Subir Roy

Senior economic analyst

Perhaps the most disturbing aspect of the current economic slowdown is that the middle class in the country has stopped growing. This is contrary to the process that had begun in the nineties and continued till lately with a pause in between during a setback, like the global economic crisis of 2008.

As economic growth picks up and the additional income is more or less evenly distributed, people in lower income groups are able to afford what they earlier couldn’t or these account for a lower percentage of their income than earlier. This leads the way to growth in the middle class. But there is trouble when people cut down on even biscuits and soap, as is the case now.

Rathin Roy, director of the National Institute of Public Finance and Policy, looks back and offers the following comparisons. In the early nineties, a junior lecturer would need four years’ salary to pay for the cheapest car. At today's salary and car prices, he would need six months. An airconditioner would have been equivalent to seven months' salary, today it is 10 days. A Delhi-Mumbai air ticket would have taken care of one month’s salary, today it is one day.

As reforms reduced the cost of doing business, factory owners produced goods at a lower cost, priced them more affordably and the demand rose. To meet the demand, businesses invested in new capacity. This meant new jobs and higher pay for all as businesses passed on to workers some of the fruits of the low- cost structure, also enabled by economies of scale. More workers and more pay for all workers meant more spending power and boost to demand and growth.

Over time, the demand for affordable housing increased as the emerging middle class sought to live better. More economic activity meant more tax revenue, enabling payment to aid consumption of universal merit goods and subsidised food. This eventually led to the MGNREGA employment guarantee programme. A virtuous cycle was created whose leitmotif was an expanding middle class, defined by Indian standards, of course.

But the momentum of this model has begun to plateau as the topmost earners have begun to take more and more foreign holidays and buy imported branded consumer goods. The model can be sustained by putting more purchasing power in the hands of those with incomes below the top and from the minimum wage upwards and making available affordable goods for them.

Unfortunately, minimum incomes have stagnated because of the poor performance of agriculture. Plus, wage increases via MGNREGA have not kept pace because of a lack of commitment to the programme started by the previous regime. Hence, we have seen a strong migration from the countryside to urban areas seeking jobs in the burgeoning construction sector.

Two specific developments put a break on this process. Infrastructure projects stalled owing to the problems created by the failure to keep maintaining their ease of doing business. Additionally, lack of fresh promoters’ equity to go with burgeoning project costs owing to delayed completion, got banks into trouble. Eventually, troubled banks stanched the flow of funds to NBFCs, which in turn failed to keep the construction sector going. So, the option of securing urban construction jobs to keep raising minimum wages was gone.

At this juncture came a policy-induced mishap — demonetisation. It stopped the growth of the middle class by dealing a body blow to agriculture and the unorganised sector, says Pronab Sen, former chief statistician of India.

Agriculture, being cash-based, was starved of cash, leading to a fall in agricultural prices and stagnation in real wages. Small businesses which largely ran on cash had to either close temporarily or cut down their operations. This again halted the upward mobility of incomes and the growth of the middle class.

The situation in agriculture has been particularly acute. Cash shortage and fall in agricultural prices have led to farmers’ default on repayment of bank loans. This has made them ineligible for fresh loans. Hence, farmers have had to turn to moneylenders. “India has spent 40 years to bring farmers to banks and this move on demonetisation has undone that effort. The government’s decision to phase out cash,” with several new rules discouraging its use, “is extremely damaging and should be reversed,” says Sen.

To get out of the present impasse, the government needs to address the overarching issue of agricultural and resultant rural distress. Foremost, it needs to reform the market for agriculture, both domestic and cross border. Agricultural produce marketing committees should go and restrictions on inter-state movement of agriculture produce should be removed. Plus, periodic restrictions on the import and export of agricultural produce should go. Once this happens, the huge difference between what the farmer gets and the consumer pays, will go down, providing a boost to farm incomes.

Also, the government needs to come out entirely in favour of reforms. Currently, domestic reforms are in while trade reforms are out. But unless trade reforms take place and there is import competition, the competitiveness of Indian firms will not improve and the forward progress of the economy will be halted.

When reforms came in the nineties, the rupee was devalued and tariffs lowered. The industrialists who made up the Bombay Club tried to stall some of the reforms but were overruled. Today, India has walked out of a trade pact with other Asian nations, setting back trade liberalisation. Indian business has the government’s ear. This does not augur well for the future of the economy and the health and size of its middle class.