Slow economic recovery looms

Macroeconomy: Put fiscal house in order, move on tax reforms, ease state fetters on market forces

The Economic Survey tried to paint a realistic picture of the economy, pegging gross domestic  product (GDP) growth at 5.4-5.9 per cent for 2014-15, after it had dropped to below five per cent in the previous two years. A day ahead of the Budget, it prescribed the government to go for fiscal consolidation and simplify tax  policies to revive the investment climate.

The Survey, presented in Parliament by Finance Minister Arun Jaitley, wanted the government to rein in inflation and ease procedures for higher  growth.

Even then, economic growth could tilt towards the lower end — 5.4 per cent — of the projected  band this  financial year and it might not be before 2016-17 that the economy would revert  to seven to eight per cent annual growth, cautioned the Survey.

“Growth in 2014-15 is expected to remain more on the lower side of the range,” it stated. This is  because steps undertaken to restart the investment  cycle, such as project clearances and incentives given  to industry, are perceived to be playing out only gradually. Also, there is benign growth outlook in some Asian economies, particularly China, there is still an elevated level of inflation that limits the scope of the Reserve Bank of India to reduce policy rates and there are expectations of a below-normal monsoon.  

Geopolitical tensions might also pose a downside  risk to the projections, it warned.

When asked whether the Survey was tempering expectations about economic  growth, H A C Prasad,  one of the authors, said: “The Survey is realistic, given what has happened in the previous two  financial years.”

In the previous three financial years, its projections far exceeded the economy’s actual performance on growth (see chart). Last year, it gave a range of 6.1-6.7 per cent for its projection, an overestimate.

Prasad, a senior economic advisor in the finance ministry, said the Survey talked about higher probability towards 5.4 per cent growth because both manufacturing and mining had not picked up, there was uncertainty over the monsoon and despite merchandise exports growing significantly in the first two months of 2014-15, the Baltic Dry Index (a measure of freight movement by sea) was down, putting a question mark over revival in global  trade.

Noting the proportion of working-age population was likely to increase from approximately 58 per cent in 2001 to a little more than 64 per cent in 2021, the Survey said the defining challenge in India today was generating jobs and growth. As such, it is important to create a conducive environment for companies to invest.

What to do
Since investments are made on the basis of long-term growth prospects, the key to reviving investment in India lies in reviving the growth of the economy. To do so, reforms are needed on three fronts. Namely, creating a framework  for sustained low and stable inflation, setting public finances  on a sustainable path by tax and expenditure reforms, and creating a legal and regulatory framework for a well-functioning market economy, said the Survey.

It suggested the government introduce the central  part of the Goods and Services  Tax to begin with, and simplify the Direct  Taxes Code.     

It also offered a long-term tax reform recipe —  abolish “bad” taxes such as cesses, surcharges,  transaction taxes and dividend distribution tax.  

In a situation of low growth and high inflation, the Survey mentioned stagflation as well. “The possibility of stagflation raises  serious challenges  for macroeconomic  policy,” it said. Stagflation is a condition of slow economic growth accompanied by persistent high inflation and unemployment.