Time to Re-form the Reform.

India’s GDP has grown at an annual average rate of 7.5% during the five years ended 2018-19. This average figure marks the considerable variation in the annual rates, which peaked at 8.2% in 2016-17, and bottomed out at 6.8% in 2016-17. In the quarter ended March 31, 2019, growth fell to the worrying level of 5.8%. According to most reports, recovery in the growth rate appears sluggish. Some commentators point to the monetisation as a key trigger that led to the fall in the growth rate. But proponents of this view have provided no credible supporting evidence. Given that demonetisation took place on 8th November 2016, it’s impact should have been concentrated in 2016-17, which is not in this case. One may invoke the argument that the effect took place with a lag. But given the instantaneous nature of the event absence of any perceptible immediate impact greatly undermines the validity of the arguments. According to another hypothesis, introduction of the goods and services tax (GST) and the other disruption accompanying it were responsible for the decline. While there is some truth in this, GST disruption is largely behind us. I would argue that the most important sources of the slowdown is weakness in the financial sector. The beginning of the decline in the growth rate in 2017-18 coincided with the sharp decline in the growth of credit by public sector banks (PSBs) due to large and rising level of non-performance assets (NPAs). Credit by non- banking finance companies (NBFC’s) partially filled the gap but it’s growth could not be sustained. Though growth in bank credit has seen some recovery within the last year, it remains sluggish.

Doubts Remain

Three recent measures- surcharge on income tax on the rich, protective custom duties on several products and introduction of jail term for failure to meet prescribed corporate social responsibility (CSR) expenditures have also hurt market sentiments. Though their impact on growth will be felt over time, they have raised doubts in the minds of the investors. The decision to proceed with four labour codes, without any reform of underlying labour laws, has reinforced these doubts. Pulling in the opposite direction are several reformist measures. Of immediate relevance is the amendment to the Insolvency and Bankruptcy Code (IBC) which will help speed up much needed resolution of NPA’s of PSB’s. The National Medical Commission Act (NMCA) is a bold , pathbreaking reform that promises significantly improved outcomes in the medical education and hence the health sector. The decision to privatise several PSU’s if implemented would go a considerable distance. Finally a Higher Education Commission Act and National Research Foundation, announced in the recent Budget speech, carry the potential to entirely transform India’s higher educational system. In the current fiscal year, growth is unlikely to recover in a major way. Two factors pose a challenge to private corporate investments which is critical to growth acceleration. First, available data suggests that once we take into account off-budget borrowing of the government , the combined fiscal deficit of the Centre and states is mopping up almost all of financial savings of households. Secondly, the financial markets remain weak, undermining intermediation of available financial savings by corporations. Immediately corrective actions, both falling under the purview of RBI: cut in the interest and allow the rupee to depreciate. Due to continued low inflation, real interest rate is exceptionally high today. Therefore RBI is in a position to affect a significant cut in it without fear of missing it’s inflation target, with is allowed to rise up to 6% under current the correct legislation. While improving investor sentiment, an interest rate would also help improve the financial health of the banks.

Stand Up and Be Counted.

In the longer term, there is no short-cut to faster growth other than accelerated growth in productivity and investment. Both require pro-markets reforms. It is futile to blame consumption demand when the real problem is the inability of our industries to stand up to foreign competition. The world merchandise export market is $17 trillion, and India’s share in it is just 1.7%. A more competitive domestic industries could have easily escaped weak domestic demands by exporting more. Auto industries at the forefront of those complaining about weak consumption demands, offers the most compelling examples from this perspective. After 70 years of absolute protection, it has less then one percent share in the world exporters of passenger cars. Even in the domestic markets, it is able to survive only because of 50-100% tariffs on imported cars allows it to charge the customer one-and- a half times the price customers in the rest of the world pay for similar cars. This must change.