India entered the pandemic with declining growth and limited scope for a conventional and large fiscal stimulus. We had noted in an article (IE, January 20, ‘Limited scope for sharp recovery‘) that India’s slowdown was largely a structural demand problem that cannot be addressed through piecemeal aid and transfers. Consumption growth provides limited scope for a sharp recovery over the medium term without exogenous (and often unsustainable) triggers. With or without the pandemic, the prescriptions for long-term growth remain the same — broaden the consumer base by empowering the low and middle-income consumers rather than pushing consumption itself. As India emerges out of the “relief” phase, the policy focus needs to shift towards the “rebuild” and “recover” phase.
India’s real GDP growth prospects are in sharp contrast to the growth seen over the past 10-15 years when it was marked by three phases: First, when growth was driven by domestic investment and global growth; second, the post-global financial crisis stimulus phase, and third, the leveraged consumption phase. The economy is estimated to have lost around Rs 20-28 trillion due to a lockdown, with FY2021 growth likely to be around (-) 11.5 per cent. So, why can’t the government just spend to revive growth?
First, in all likelihood, temporary incomes coupled with job/income uncertainty will induce precautionary savings without any impact on growth. Second, the fiscal situation was weak even before the pandemic. With revenues having cratered, funding of additional expenditure is through higher borrowings. Any incremental debt should be seen in the context of future investments being hampered due to current consumption.
It is easy to prescribe abandoning fiscal prudence or “printing money” to fund spending. But the risk-reward ratio is far from being benign. We should note that India’s public debt/GDP will likely reach around 85 per cent and the consolidated gross fiscal deficit to GDP ratio could be around 12.5 per cent this year. Assuming gradual fiscal consolidation, these metrics will take quite a few years to revert to pre-COVID levels. Rapid consolidation will adversely impact growth. This sets the base for any kind of “stimulus” — it should be well-targeted and have a large multiplier effect.
In a recent report (India Economic Reboot: Bold or nothing, July 22, Kotak Institutional Equities), we argued that India needs to broaden its consumer base beyond the top 10-20 per cent of the population to improve long-term growth prospects. This cannot happen with regular doses of consumption stimulus but through creating steady and well-paid employment for the bottom and middle segments. To borrow the thought from the economist Rathin Roy, the composition of aggregate demand needs to change and focus beyond the top 100-150 million-odd consumers.
We have found that the NSS 68th round consumption survey indicates that in urban India, the top 20 per cent of the population accounted for nearly 55 per cent of discretionary consumption and 45 per cent of all consumption. We sense that a more recent survey will indicate that this mix has become further skewed. The narrow consumption base coupled with uncertainty over the demographic dividend could belie India’s long-term investment attractiveness. Further, if the pandemic results in a prolonged retrenchment of the workforce, the faultlines will deepen in India’s labour market.
The PLFS 2018-19 report places around 24 per cent of the workforce in the regular wage/salary category. However, within this segment, around 40 per cent do not have a written contract, paid leaves, or security while 70 per cent do not have any written contract. The “safe” cohort of India’s workforce is extremely small. Workers at the highest risk from the economic shock will be the casual or self-employed labour and in some cases even regular wages/salaried workers who are not part of the formal sector. These sharp skews in consumption and labour may work well when it is business-as-usual but become a substantial risk for a consumption-led growth in the aftermath of a crisis.
The PLFS 2018-19 report indicates that around 50 per cent of the rural non-agriculture workforce and 35 per cent of the urban workforce is engaged in the construction and manufacturing sectors. Thus in the context of this composition in consumption and the labour force, the rebuild and recover phase should aim for inclusive growth (a wider consumer base) with infrastructure and manufacturing as the two pillars. To make manufacturing easier, the focus should be on labour reforms, fewer/quicker approvals, reducing the compliance burden, and promoting export-oriented sectors. The government has been pushing for electronics manufacturing and import substitution in some sectors. However, policies should not become too inward-looking such that export promotion becomes difficult.
Ideally, most public spending should be directed towards sectors such as roads, railways, infrastructure, healthcare and educational facilities to help rebuild the economy. To promote infrastructure creation along with private sector participation, the government needs to charge an economic price for goods and services such as power, irrigation, and public utilities, establish the rule of law with minimal interference in pricing, streamline processes for quick approvals and ensure timely payments to private operators. It should also signal its vision along with a financing strategy through sharper expenditure management, enhanced market borrowings (including tax-free bonds for retail investors, external assistance from multilateral/bilateral agencies, and ultra-long-term bonds), setting up of a Development Financing Institution, and an asset monetisation programme.
To achieve economic growth of 7-8 per cent that is sustainable over the next decade, the government needs to start addressing some of the traditional sore points such as the large infrastructure deficit, the weak financial sector, archaic land and labour laws, and the administrative and judicial hurdles. If it fails to do so, India’s potential growth will be much lower and we risk losing a decade of favourable demographics.
This article first appeared in the print edition on September 2, 2020 under the title ‘To rebuild and recover’. Rakshit is senior economist at Kotak Institutional Equities and Puri is economist at Kotak Mahindra Bank. Views are personal
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