Recovery is here, now for reforms

The recent uptick in economic activity is heartening, but urgent reforms are needed for growth to be sustained

The economy is showing clear signs of improving. Monthly sales tax revenues have crossed the Rs 1-trillion mark, manufacturing indicators have rebounded, and even sluggish capital-intensive industries have seen something of an uptick. 

Better still, some areas that had been persistently lagging are finally improving. The service sector is beginning to expand. And while rural demand held strong over the summer, urban demand is catching up, too. 

But growth is as much created by supply. And there is some good news there as well. Through the pandemic, three supply-side constraints hurt activity, namely logistics, labour and funding. 

Thankfully, logistics and labour constraints have eased. The wedge between inflation at the wholesalers and the consumer has narrowed, suggesting that logistics and transport-related constraints are easing. And as the agricultural harvest season ends, there are indications of rural employment and real wage growth easing, leading to a return of labour to their urban jobs. 

Sadly, funding constraints remain. At a time when reserve money growth is elevated (at 14 per cent y-o-y), indicating more money has been supplied to banks by the central bank, bank lending remains weak (at 5.8 per cent y-o-y). And more worryingly, overall credit to industry is flat. If banks remain risk averse, this could even be a drag on India’s ability to grow over the medium term. All of this could begin to show up more clearly once the festival-led bounce in demand subsides. 

To work out an estimate of how much the post-pandemic potential growth could fall, we rely on previous multi-decade lows and how long a recovery took for each factor of production (capital, labour and total-factor productivity, or TFP). India may not have cleaned up, for instance, on its pile of bad loans effectively after previous slowdowns, so this method, we believe, captures these unique traits of Indian policymaking. 

We find that potential growth was already falling, from 7 per cent-plus on the eve of the global financial crisis to 6 per cent on the eve of the pandemic. And it could fall by 1ppt through the pandemic months, to 5 per cent in the post-pandemic world. 

To be fair, potential growth is likely to fall in other parts of the world, and India is unlikely to be a standalone. But it would be at odds with previous expectations of potential growth rising, and will also mark the lowest potential growth for India since the turn of the millennium. Is it possible to limit the fall in potential growth? Or perhaps raise it back up over time?

India’s central bank has been quick in providing large monetary stimulus. It has cut rates, provided ample liquidity and announced plans for restructuring loans. It has even innovated, buying state government bonds for the very first time. 

On the other hand, the fiscal support package, equivalent to under 2 per cent of GDP, has been amongst the lowest in emerging markets. That’s understandable given the weak starting position of the government’s finances. Even before the pandemic hit, public debt was elevated at just over 70 per cent of GDP. And despite subdued growth in government expenditure, public debt could cross 90 per cent of GDP on the back of revenue shortfalls.

Even with these constraints, there is perhaps room for some well-targeted spending, especially in three areas — social welfare for the urban poor, recapitalisation of banks and more public capital expenditure. 

But all of this misses out the need for reforms, a critical ingredient for growth. These are potentially more important and longer-lasting than monetary and fiscal stimulus, which comes with a price tag of inflation and more indebtedness. 

The problem is reforms in India often become an exercise of ‘fire and forget’. They are announced but not followed up. The GST reform from a few years ago is one such example. It needs to be revisited to meet its true potential. Some important agriculture and labour reforms have been announced over the last few months. But the real fruit will be harvested only when they are implemented successfully. 

Our analysis shows that nurturing an environment of policy certainty with regard to taxes, foreign direct investment rules and payment of dues to small businesses can have a meaningful impact on kick-starting the private capital spending cycle. Focusing on rules-based policy making can help, too. And putting initiatives like the Insolvency and Bankruptcy Code into cold storage just when it is needed most is a step that needs to be revisited and reversed. 

As global supply chains are rejigged, India has a limited window of opportunity to increase its share in global trade. Strategic steps like a cut in corporate tax rates and production incentives for sectors like electronics are good steps. But they are not enough. 

What India needs is a more comprehensive framework encompassing all the different aspects of being an efficient producer. For instance, fast-tracking recent state plans to create large land banks, particularly those near revamped ports and airports, and to make them efficient manufacturing hubs with low regulatory burden. The practice of slapping tariffs on a variety of goods over the last few years may turn out to be counterproductive. As trade economists warn, they could simply end up acting as a tax on exports, making them uncompetitive. India needs yardsticks to measure progress on these fronts in real time, and it needs to take corrective action when they are not met. 

Recent upticks in economic activity are heartening. But the hope is that they provide encouragement for triggering a string of reforms that are necessary to sustain them. 

The writer is Chief India Economist, HSBC Securities and Capital Markets (India) Pvt Ltd