What Ails The Indian Economy?

Mismanagement In NDA 2

The aspirations of 1.3 billion people lies in the hands of the government. The Indian economy grew at 5% and 4.5% in the first two quarters of the financial year 2019-2020 respectively. At a time like this, there is no doubt in the minds of the common people that the 5 trillion economy target set by the govt, which is to be achieved by 2024 is a distant dream. If India is to be a 5 trillion economy by 2024 it has to grow consistently at 9-10% each year and we are nowhere close to it. The Indian economy has been declining for seven straight quarters and the govt has done more harm then good. The Finance ministry it seems, only acknowledged the slowdown in August 2019, nearly 20 months after the slide first started.

Budget 2019-2020, instead of addressing the problems faced by the industry, only piled on the misery with a steep increase in surcharge levied on the ‘super rich’. Although such a concept is not new and perhaps even right according to certain Socialists, It is really astonishing, given the sheer magnitude of the finance ministry machinery, that the govt failed to envisage that such an increase will also apply to FPIs (foreign portfolio investors). It led to a sudden pullout of FPIs from the Indian Market dealing a double blow to the industry which was already suffering from a liquidity squeeze. Instead of reversing the surcharge immediately, the Finance minister admonished the FPIs to follow a cumbersome process of converting from trusts into companies to avoid the surcharge, further fuelling the discontent and damaging the sentiment in the industry. The industry’s demand for abolition of angel tax was also not paid heed to.  Good sense prevailed and both of these were eventually rolled back in late august but only after all the damage had been done in terms of sentiments.

According to the father of modern economics, John Maynard Keynesian, sentiment is a very integral part of economics. Simple economic theory advocates that at the time of a slowdown, it is imperative to reduce taxes and increase govt’s capital expenditure, but the govt did exactly the opposite. According to budget numbers, Capital expenditure is scheduled to grow a meager 6.9%, after it grew over 20% last year!

In August-Sept, the FM came in with a slew of measures designed to arrest the slowdown and revive the animal spirits. Among these, was the sharp reduction in corporate tax rate to 22% for existing domestic companies from 30% and 17% for new manufacturing companies. We must concede to the fact that it was a much needed reform enabling Indian companies to be more competitive and putting us on par with other countries around the world.

However two questions still remain:

1) Was India a bit too late to seize the opportunity created by the ongoing trade war between China and USA? Amidst the trade war, companies were trying to move out of China in search of some better opportunities. If the corporate tax cut had been announced sooner, India would have been an ideal location due to its large domestic market similar to China. But due to the inaction of the Indian govt, India missed the bus, and these companies found another alternative; Vietnam. Despite being ravaged by war and primarily a very agrarian society, Vietnam has grown exceptionally well in the last decade or so and now is the fastest growing economy in the world. It was a golden opportunity for India to attract large Investments and thus revive the animal spirits in India.

2) Was the corporate tax cut, the correct medicine for the disease? Experts have noted that the present slowdown is largely due to weak consumption demand ie. it is a demand side problem. A reduction in the corporate tax rate primarily addresses problems which are present on the supply side and does not affect consumer demand directly. It certainly improves the balance sheet of companies affected by the present slowdown but it does not do anything to revive demand directly. The regularization of GST on the other hand would have been the perfect remedy in order to revive consumer demand directly. The govt has stated for a long time now that it wants to reduce the number of GST slabs to 3 from the present 4 and have only demerit goods in the 28% category. This would have been the perfect opportunity to bring about such a change and revive consumer demand because inflation is also largely in check and a rapid increase in demand would not have caused too much inflationary pressures.

But everything said and done, the corporate tax cut alongwith GST and the insolvency and bankruptcy code (IBC) have been the only real economic reforms brought about by PM Modi’s govt in the last 6 years.

India’s Trade Story

If we see the rapid growth brought about by certain Southeast and East Asian countries namely China, Japan, South Korea, and now Vietnam, it has largely been on the back of massive export expansion. No Economy in the past two or three decades or so, has expanded without robust export growth. Indian exports have largely been stagnant for the past 5 years. The govt has repeatedly blamed the weakening world economy for this stagnation. What we fail to understand is that Vietnamese exports have grown a whopping 300% in the same period. Are India and Vietnam operating in two separate worlds?

India’s exports grew on an average 20% every year from 2004-05 to 2010-11, whereas they have remained largely stagnant from 2014-15 to 2017-18. Now, if we see most of the free trade agreements that India has signed, they are between the years 2002-03 to 2010-11. According to WTO, the effective applied weighted average custom duty in India is 5.78% and that of Vietnam is 2.65%. India’s import tariffs are almost double to that of Vietnam. Philippines also has a weighted average custom duty of 1.66% and registered a trade growth of 2.81% compared to a world growth of 1.5%. India in the same period registered a trade growth of -1.10%. We are relatively a much closed economy as compared to them which is evident from our high custom duties. History tells us that open economies have by and large outperformed closed ones. It is time for India to open its doors to new possibilities and not be afraid of global competition.

November 4, 2019 was a sad day. We decided to walk out of the Regional Comprehensive Economic Partnership (RCEP) negotiations at the eleventh hour, admitting that we couldn’t compete with Asia, especially China. If India had joined, RCEP would have been the largest free trade area comprising 16 countries, half the world’s population, 40% of global trade and 35% of the world’s wealth in the fastest growing area of the world. The deal on offer was a reasonably good one. Many of our fears had been addressed including protection to farmers from import of agricultural products and milk. A quarter of Chinese goods had been excluded, and for the rest a long period of tariffs was allowed from 5 to 25 years. The deal offered a unique safeguard from a sudden surge of imports from China to India for 60 of the most sensitive products.

If much smaller countries in Asia – Vietnam, Philippines, Laos, Myanmar – can compete and have joined the RCEP, Why can’t India? Why do we need tariff protection, normally meant for infant industries? Why are India’s companies still infants after 72 years of Independence? First we need to get over our inferiority complex and our old attitude of export pessimism. Pessimists fear a growing trade deficit. They forget that low cost, high quality imports are necessary to enter global supply chains. Competition is the best school in which entrepreneurs learn to hone their skills. India should have joined the RCEP. We can still join RCEP by March 2020. Consider this period a pause to get our house back in order. It’s never too late to do the right thing.     

OPPORTUNITY TO REFORM

It is often said that a period of crisis is the best opportunity to bring in sweeping reforms. India too had witnessed a balance of payment crisis in 1991, after which the duo of PM Narashima Rao and Dr. Manmohan Singh ushered India into a new era. They revolutionized the Indian economy. India won its political freedom in 1947 and its economic freedom in 1991. UK too witnessed a crisis in 1965-69 after which Ms. Margaret Thatcher came in and incorporated some bold reforms which catapulted the British economy to new heights and helped them get over the menace created by the labour unions. The present situation is by no means a crisis. Most of our macro economic indicators like fiscal deficit, Inflation, current account deficit are in control, but there is a blip in some other indicators especially pertaining to economic growth. Nonetheless, it provides the present administration a chance to mend our ways.

There is need for land and labour reforms. The govt had brought in the land acquisition bill in 2015, but it failed to clear it in the Rajya Sabha. Now, the govt has enough numbers to push it through both houses of parliament, but is it willing to? Though most of our country has transformed into a capitalist one, our labour laws still have the smell of the old socialist era. There is need to reform our rigid labour laws that protect jobs, not workers. Companies have to survive in a downturn. When orders decline, you either cut workers or go bankrupt. Successful nations allow employers to ‘hire and fire’ but protect the laid off with a safety net. India should have a labour welfare fund (with contribution from employers and government) to finance transitory unemployment. We should not insist on lifetime jobs.

Another priority area is disinvestment of certain public sector companies. Govt has no business staying in business. It is time for the govt to cut its public sector wage bill and direct the money towards high class education and healthcare. India does not have a single university in the top 300 best universities of the world. It is said that human resources are our biggest strength. It is certainly true in terms of quantity. How are we addressing the quality?

India is the largest exporter of labour in the whole world. But we do not gain any monetary advantage from it. We are exporting labour for free. It is time that India starts negotiating trade deals to our advantage. We need to realize that we are not a large goods producing nation. Our biggest unutilized strength is our labour export. We need to negotiate trade deals with western countries as well as the middle eastern countries, to the effect that they remit to India, a certain percentage of taxes paid by Indian’s staying abroad, in return of lower import tariffs on their goods. Such a deal would lead to huge revenue inflow to India. We would earn vital foreign exchange and also prosper from cheap imports, resulting in a consumer surplus. So the revenue that we would lose due to lower direct tax collections, the govt would be able to recover it in much larger quantities from our indirect tax collections due to our large consumption base. India should be the Information and Service hub of the world and it certainly has all the ingredients to be one.

It is time India undertakes such bold reforms and the present slowdown is the perfect opportunity. Such reforms require immense political courage. It will be interesting to see whether PM Modi has the goods, whether he is a natural reformer like Lady Thatcher or a reluctant reformer like Mr. Narashima Rao. Whatever be the case, India needs another set of bold economic reforms.