I suppose we should be grateful. After months and months in which voices have been raised in concern about a serious and structural slowdown in the Indian economy, the central government has finally accepted that it may, perhaps, have a teensy-weensy problem on its hands. Finance Minister Arun Jaitley has met various senior officials, and a revival plan has reportedly been presented to Prime Minister Narendra Modi. Better late than never, you might say. Well, that depends on exactly what the government eventually winds up doing.
The details of the plan are still unavailable as of this writing, but there is every reason to believe reports that its main weapon will be increased government spending. Even if not presented as such, it is likely that increased spending will be the only easily operationalised aspect of any revival plan. And thus voices from the ruling party to the commentariat to even the State Bank of India have begun to argue that the government should ignore its achievements on fiscal consolidation, and start throwing money at the slowdown.
It is impossible to exaggerate how bad an idea this is. In fact, I am appalled that it is being made at all.
First of all, prioritising government action would suggest that no lessons have been learned by the Modi government from its mismanagement of the economy thus far. Since it took office, the government has focused on the following approach: First, move towards correcting some of the business-cycle problems it had inherited; second, take advantage of tax growth and expenditure savings on account of cheaper oil; third, spend the proceeds on infrastructure without cutting other spending; and fourth, prioritise positive messaging about the economy in order to raise investors’ “animal spirits”.
While this is a coherent economic programme in theory, it was poorly conceived and implemented. It rested on a fundamental misdiagnosis of the problems and how they could be solved. For one, it assumed that higher infrastructure spending would solve the slump in private investment; government spending would “crowd in” private investment by making returns look more attractive. This has clearly not happened. Private investors are still concerned about overcapacity, weak demand, and the security of their investments in India. And thus, private investment, and growth, continue to struggle.
In addition, those aspects of the programme that were in fact of importance — such as cleaning up the bad loans problem — were not prioritised in effect. This is where the mismanagement comes in. The government took years to move on these problems, and thus they continue to hang over the economy’s head like the sword of Damocles. Ministers have often talked up the decisiveness of this government, but where politically risky decisions were necessary in figuring out who took haircuts as a consequence of boom-era bad choices — consumers, public sector banks, or promoters — they are still to be taken in more than three years, so I am not feeling like giving the government any points for decisiveness. The government has known since the day it took office that the banking sector was in trouble, yet its action to repair it has been ineffective and poorly managed, and based around talking points leaked to WhatsApp groups instead of institutional change at banks.
And finally, given that the programme depends on an external impetus — the oil price bonanza — it is inherently unstable, unsustainable, and politically risky, as demonstrated by the increasing clamour for petrol taxes to be reduced.
As a consequence of this poor economic management, the economy has now been slowing for six quarters in spite of benign macro-economic conditions, a growing world economy, and increasing government spending. You have to really bungle to produce 5.7 per cent growth under the conditions this government is currently facing. So, you may well ask, surely the logical approach to this situation would be to revisit the economic programme decided in 2014 and correct it? What is not logical is to instead throw out of the window the one genuine accomplishment of this government — its sticking to a fiscal consolidation path that it inherited. Government spending has been increased in each Union Budget, and that has not helped the economy recover. So how can further spending be even considered, especially as India’s history with stimulus packages has been poor?
Illustration by Ajay MohantyMany of the economy’s current problems can be dated to the pre-2008 boom, but many are also the product of the easy money on offer when the government panicked after the 2008 financial crisis. The fiscal deficit rose to dangerous levels, reform was postponed, taxes were cut, loans were rolled over, and so on — all justified by the crisis. At least that was a real, global crisis. Are we going to make the same mistakes to get out of the current, self-inflicted one? There is no reason to suppose the Modi stimulus will be any more effective or any less dangerous than the Mukherjee stimulus. In spite of pious and repetitive statements about a culture of honesty, the plain fact is that the fundamental political economy of the country has not changed since 2010; in the absence of institutional reform, the same incentives still exist to make the same mistakes that were made then.
The problem is that the government seeks to address, on this occasion, a structural problem through attempting counter-cyclical policy. This is more than a business cycle slowdown. A business cycle slowdown is what India had in 2012-13, and we were pulling out of it well before Modi took power. Our current slowdown is a consequence of structural problems: An increasingly uncompetitive economy, a lack of property rights and security of investment, an incompetent administration at all levels and a poor regulatory environment. These are the structural issues that need to be addressed in order to restore India to a higher potential growth path. With every passing day they go unaddressed in a globalised economy, India’s potential growth actually comes down, as it gets less and less competitive.
Address these issues, and demand, and investment appetite and growth will return. Spend money without fixing these problems, and they will only get worse. But judging by this government’s track record, it will be unable to think beyond what a few bureaucrats recommend. And bureaucrats tend to like spending money, not losing power. Until India has a government in which policy is not made by bureaucrats, it will struggle to pull itself out of the Modi slowdown.