Given the macroeconomic context, India should have recorded higher economic growth this year

By tradition the Economic Survey used to be presented to Parliament on the eve of the Union Budget. But then, the government under Prime Minister Narendra Modi is known to break with tradition. For instance, it advanced the presentation of the Budget by one month; it has done away with a separate Railways Budget; and it has merged the two categories of “plan” and “non-plan” spending. These are significant breaks from the past. The big one, of course, is the winding down of the Planning Commission itself. So also, in a break from tradition, this year, the full Survey was not presented at the beginning of the Budget session. Only Part I was presented. This is the part which is policy oriented and future looking. It reads like a doctoral thesis, with many conceptual ideas and analytical pieces. It covers various topics: the puzzle of lack of convergence in growth of States, the challenge of governance of cities, a new fiscal framework for India, etc. It also presents a much-awaited longish piece on demonetisation (without giving away precise quantitative estimates of its impact). Such is the impression of the scholarly tome on the research community, that the University of Mumbai has adopted it as a textbook in its economics courses.

The update

But Parliament wants hard data, which is in Part II of the Survey. This data has the stamp of authenticity. The data about the year gone by was not available in February, hence the delay. The second part of the Survey comes almost six months later, so has some additional analytical pieces. The data that it presents and its prognosis for the near term future call for sobering reflection.

Economic growth for fiscal year 2016-17 was 7.1%. This was the year when oil prices and inflation were moderate, monsoon rains were abundant, inbound foreign direct investment was at record peak, the currency was stable and the fiscal deficit was under control. With such macroeconomic context, the year should have recorded at least one percentage point higher growth than the previous year. But that was not to be, and demonetisation could be the biggest reason. Indeed the second half of the last fiscal saw the growth rate plummet by 1.2 percentage points compared to the first half.

The Survey says that signs of slowdown were evident even before the surprise November announcement of demonetisation. Next year too, the Survey forecasts a growth closer to its lower bound, possibly lower than 7%. In three years if the economy has missed one percentage point every year, cumulatively that’s a permanent loss of national income of close to ₹5 lakh crore in nominal terms. The continuing deflationary trends arise from lower investment ratio, low farm prices especially for non-cereals foods, the cutting back on development spending by State governments owing to the burden of loan waivers, and of course the twin balance sheet problem (more about this below). The Survey cites the example of Uttar Pradesh which had to slash its development spending by 13% in order to accommodate the farm loan waiver.

Industrial problems

On the industrial front, the news is not upbeat. The latest June data on the index of industrial production (IIP) shows negative growth, i.e. contraction of the index, which is the first in the last four years. It may very well be due to de-stocking of warehouses before the July 1 launch of the Goods and Services Tax (GST), but it does not seem so. The contraction is particularly widespread across manufacturing sectors, with 15 out of 23 industries showing negative growth. This is where the twin balance sheet problem hits hardest. Bank balance sheets are stretched with a non-performing assets (loans) ratio close to 10% of their total loan. This is higher than the capital base available to most public sector banks. So technically their net worth is negative. On the other hand, corporates too are reeling under stretched balance sheets, burdened by excessive borrowing at high interest rates (from the past), excess capacity and not-so robust demand for their products. Their situation is made worse with the flood of imports, which take away their domestic market share. The strong rupee makes imports more attractive. Under the GST regime, the countervailing duty paid in lieu of excise (now GST) is now tax deductible. Earlier it was not for many products. This makes imports that much more attractive in comparison with domestically produced goods. The strong rupee has also been flagged by the Survey as potentially harming the domestic economy.

Is the weakness in industrial growth a structural problem or a cyclical one? If the latter, then we should see an upswing. But it also has long-term structural dimensions. The investment-to-GDP ratio has been steadily falling for five years in a row. Of this the private sector component growth is abysmally low. The bank credit growth to industry has been consistently negative since September 2016. How does one revive this sentiment, so that one sees at least two dozen prominent industrial projects worth ₹10,000 crore each? At a time when the Sensex scales new peaks, somehow that sentiment is not infecting physical investment in plant and machinery. Opportunities from Digital India, Smart Cities Mission and Housing for All are huge, but a kickstart is needed.

The third area highlighted by the Survey is the financial sector, including money and banking. It implicitly blames the high interest policy of the Reserve Bank of India (RBI) for thwarting industrial growth. Even when the monetary policy framework has now become focussed on inflation targeting, the RBI’s forecasts have overshot six out of 14 times in as many quarters. Isn’t it being too conservative? Why can’t it slash interest rates aggressively to enable growth? To be fair, the Chief Economic Adviser has said this many times, so the Survey is echoing the Ministry line, but the debate is inconclusive. The inflation expectations surveys of the RBI consistently show people’s anxiety about future price rise. And it is not as if the investment train will zoom in as soon as interest rates are cut. Many other factors weigh on the minds of investors. The key problem is of course the continuing burden of non-performing assets (NPA). Repeated and innovative proposals from the RBI (under various acronyms such as CDR, SDR, S4A, or corporate debt restructuring, strategic debt restructuring and scheme for sustainable structuring of stressed assets) have not borne fruit.

The silver lining

Finally as with all things Indian, one must end with optimism. The fiscal situation at the Centre is improving. Exports are finally in positive territory. The basic building blocks of longer term growth are being put in place. The four major reforms are: GST, a new insolvency and bankruptcy code to deal with NPAs, a new monetary policy framework, and Aadhaar linkage to government services. While the near term may not cross 7%, the medium term has the potential to see a sustained 8% growth path. The caution of the Survey is tinged with this optimism!

Ajit Ranade is an economist