Leading high frequency indicators had pointed towards a deceleration in the Indian economy and the situation is only likely to improve from the third quarter
It’s now official that the slowdown continued during the first quarter of the current financial year (FY). But I am not surprised for many reasons. For starters, leading high frequency indicators had pointed well in advance towards the slowdown in the economy. India was struggling with a shadow-banking crisis that started with the IL&FS default followed by the DHFL mess, which resulted in a major liquidity crunch.
The fact that there’s adequate liquidity in the system is a positive sign but the credit crunch is being felt at the retail level and the situation is only likely to improve from the third quarter. Luckily, the Government has been trying to address a bulk of these concerns. We’ve seen Finance Minister Nirmala Sitharaman make several announcements over two press conferences, while Minister for Commerce and Industry, Piyush Goyal has further allowed Foreign Direct Investment (FDI) under different categories as he simultaneously relaxed local sourcing norms. Therefore, we’ve seen a Government that’s in full action mode as it tries to kick-start the Indian economy.
Additionally, we saw the Bimal Jalan Committee recommendations being accepted by the Reserve Bank of India (RBI), thereby giving the Government a part of its surplus so that it could be put for greater productive use. While the transfer is conservative, however, the fact that a bulk of it happened in FY 2019-20 is a positive sign.
With these announcements, two questions have been asked over the last couple of days. First is to do with what caused such a steep slowdown in Gross Domestic Product (GDP) growth from eight per cent growth in the first quarter of 2018-19 to five per cent in the corresponding period in 2019-20.
The second is to do with the recent set of announcements and whether they will have an impact on the revival of growth rates. Let us begin with the first question and we can discuss in detail the impact of recent announcements on growth going forward. At the onset, I must state that in my view, recovery is likely from the third quarter of this FY. The reason why growth slowed down from the second quarter of 2018-19 is more to do with the RBI’s Monetary Policy Committee (MPC) which determines the repo rate. Economics 101 tells us that nominal variables don’t matter, yet many continue to look at the repo rate often ignoring that it’s the real repo rate that matters.
It is not surprising that the slowdown in economy coincided with a sharp increase in the real repo rates. The fact that inflation was nowhere in sight and yet, we were slow to cut interest rates shows the extent of the MPC’s delusional understanding of how Indian, or for that matter any economy, functions in the macro sense.
The repo rates were indeed cut and we’ve seen a 110-basis point cut so far but the question is if it is enough. The answer is it isn’t, because the real rates are still too high. It’s about time we realise that interest rates don’t impact inflation but they do impact cost of capital which has an impact on investments and economic growth. There is another issue which is to do with the transmission of monetary policy, that is, lending rates have barely come down despite the repo rate cuts and therefore, borrowers continue to pay a high interest rate.
This problem was largely resolved by Finance Minister Sitharaman as last week she announced that banks would now announce repo-based lending products. This ensures seamless transmission of the monetary policy going forward and, therefore, now is the right time for the MPC to get its act together and cut interest rates by at least a 100-basis point.
The fact that the economy was slowing down was no secret, and the Government has been doing all it can to revive growth. This is visible from the fact that the Finance Minister has had multiple stakeholder consultations over the last couple of weeks and after these consultations, we’ve witnessed two massive policy announcements.
The first set of announcements was focused on financial sector reforms and a major highlight was the front-loading of Rs 70,000 crore for bank recapitalisation. This was important as there was an immediate need to infuse fresh capital into the banking system to kickstart the process of lending.
The other positive announcement was to do with the Micro, Small & Medium Enterprises (MSME) Goods and Service Tax (GST) refunds and the delays in the process. Two announcements were important in this regard. First was the decision to release all pending refunds in the next 30 days while the second was to ensure that going forward refunds are released within 60 days. These measures will ensure fresh liquidity into the system and are likely to have a positive impact in the future.
The second press conference by the Finance Minister was focussed on big bank reforms. Yes, big bank reforms because within 45 odd minutes, the minister had merged ten banks into four big banks with adequate capital and expertise. The move was long pending and it was backed up with several governance reforms to strengthen the public banking sector. As a matter of fact, in my view with this merger, the Government has paved the road for further consolidation and possibly even privatisation or at least disinvestment of some of these banks in the future.
Therefore, there’s a lot that the Government is doing to strengthen the economy. The announcements being made take forward the process of deep and structural reforms, thereby paving the way for a future improvement in our growth rates. Indeed, some of the reforms are likely to help us get to a higher potential growth rate in the next couple of years.
However, in the long run we’re all dead. The slowdown is here and the fact that we argue it’s because of external factors is not true for two reasons. India’s export growth was sluggish between 2014 and 2018 but growth was higher than what it was in the first quarter of 2019.
The second has to do with our relative share in global trade and share of exports in the GDP. Both are so small that any impact of the current trade war is not likely to cause a slowdown from eight to five per cent within four quarters. The problem is domestic and the Government too recognises it as it tries to correct it through a slew of measures.
My forecast for the first quarter growth rate was at 5-5.4 per cent and the growth came on the lower end of the spectrum at five. This suggests that there’s a far greater need for short-term anti-cyclical measures to revive growth rates. Conventional macroeconomic tools of monetary and fiscal policy are the best levers to revive economic growth in the short run as we undertake structural reforms to kick-start our growth.
With another press conference due, as stated by the Finance Minister, one is optimistic that we may see some measures for short-term revival of our growth rates. But as far as the monetary policy is concerned, we’ve gotten it wrong for a major part of the last couple of years.
Hopefully the low growth figure should make the powers that be realise their mistake and they rectify it by being aggressive in future tax cuts.
(The writer is a New Delhi-based policy researcher)
Writer: Karan Bhasin
Courtesy: The Pioneer