We have a new Governor of the Reserve Bank of India, we have a Monetary Policy Committee (MPC), and we have their first statement on monetary policy. It is tempting to read the tea leaves!
The MPC’s statement, with unanimous support, is significant not only for the cut in the policy repo rate but also for the analysis of the economic situation. The statement has come at the end of the first half of the fiscal year and, therefore, it is helpful to understand the state of the economy at the mid-point of the fiscal year which is also the mid-point of the term of the Central government.
On the global economy, the outlook is gloomy. Growth has slowed more than anticipated, trade has contracted more sharply, there is rising protectionism, and “an uneasy calm prevails on uncertainty about the stance of monetary policy of systemic central banks”.
State of the economy
On the domestic economy,
* “the outlook for agricultural activity has brightened;
* “the industrial sector has suffered a manufacturing-driven contraction;
* “inflation excluding food and fuel has been sticky around 5 per cent, mainly in respect to education, medical and personal care services;
* “in the manufacturing sector, the persistence of considerable slack…;
* “in the external sector, merchandise exports contracted in the first two months of Q2;
* “subdued domestic demand was reflected in a faster contraction in imports;
* “the decline in remittances and the flattening of software earnings warrants monitoring;
* “while the pace of foreign direct investment slowed compared to a year ago, portfolio flows were stronger.”
These conclusions were visible in the numbers that we had read in the last 12 months or more. Let me give only a few figures and say it in a way that is easy to understand:
* In Q1 of 2016-17, Gross Fixed Capital Formation (that is additional capital investment) declined by 3.1 per cent compared to same period of the previous year.
* In Q1 of 2016-17, net sales of all firms declined by 1.9 per cent and of manufacturing firms by 4.8 per cent over Q1 of 2015-16.
* During February-July 2016, credit to all sectors increased by a modest 9.5 per cent, but credit to ‘industry’ grew by only 1.72 per cent over same period last year. Credit to micro and small industries declined by 3.46 per cent and credit to medium industries declined by 10.62 per cent.
* The Index of Industrial Production for all industries during February-July 2016 increased by a mere 0.25 per cent, while for manufacturing it declined by 1.01 per cent over same period last year.
* Non-Performing Assets of banks stood at 7.6 per cent as against 4.6 per cent at the end of the previous year.
The ground reality
Now you know why there is no visible job-creation, why there is anxiety among parents, and why there is anger among the youth. Now you know why the job-creators (exporters and micro, small and medium industries) have thrown up their hands in despair. Now you know why the large business houses are investing abroad rather than in India.
It is not as if the government is doing nothing right. The government was on the right track when it affirmed its commitment to fiscal consolidation. It is doing the right thing in selling its stake in chronically loss-making public sector enterprises. It is pursuing the right strategy in pushing more investment into infrastructure, especially roads and railways. However, these measures will not be enough unless the private sector — big, medium and small — re-discovers its appetite for investment. That, unfortunately, is not happening.
Poor aggregate demand is the main reason for low investment. That ‘doing business in India’ has not become easier (despite the hype about climbing a few notches in the ranking ladder) is another crucial reason. Regulators have once again turned into controllers and have churned out reams of rules and regulations that are frightening. Investigating agencies, including the investigation wings of tax departments, have unleashed a wave of threats and terror. Litigation in commercial matters, often involving the government, has reached alarming proportions with no effective alternative dispute resolution mechanism. State governments seem to have lost interest in ‘reforms’ and seem happier pursuing ‘welfarism’.
Government losing its nerve
This is the time when the government should not lose its nerve or its focus. Unfortunately, there are signs that the government is looking for a short-term boost — increase spending to boost growth in the short-term and lure the people to be mesmerised by the dazzle of the number 7.6 (of GDP growth).
What else can one make of the government’s mandate to a committee to explore the feasibility of “flexible” fiscal deficit-targeting? And what else can one make of the first sign of “flexible” inflation-targeting that has emerged out of the statement of the MPC? Why did Governor Urjit Patel push back the deadline for achieving the inflation target from March 2018 to an unspecified “medium term”?
Both are very bad ideas. I hope the N K Singh committee will junk the idea of a flexible fiscal deficit target and recommend that the government should under no circumstances — except in a case of a declared war — breach the limit of 3 per cent for the fiscal deficit. I also hope that in the next policy statement Governor Patel will restore the RBI’s stance on inflation and re-affirm that the deadline for achieving the inflation target will remain at March 2018.