A big push in economics: Special times call for special initiatives

There is anxiety regarding the Indian economy. The present macroeconomic data operates with a lag, leaving analysis in a zone of subjective perception. However, a sequence of shocks has shaped the current environment. The economy was in poor shape in 2018 and 2019. After that, we got the pandemic, Ukraine war, United States (US) tariffs, war in Iran, and ensuing oil-price shock. The political foundations of global prosperity — liberal democracy and globalisation, built upon Western leadership — are exhibiting structural weakness. The macroeconomic conditions feature similarities to the Indian situation in the late 1980s, an era characterised by fiscal strain and a socialistic state apparatus. 

The oil shock poses to India a threat similar to the problems of the 1970s. But the central problem lies in the sustained difficulties of private investment, which forms the core of Indian economic growth. The last time the domestic private sector achieved a one-year gain of net fixed assets above 20 per cent in nominal terms was 2009-10. The last time this metric crossed 10 per cent was 2019-20. The Indian private corporate sector is exhausted and risk-averse. How can economic policy navigate these frictions and generate a sustained private-investment cycle? It is safe to say that the growth process is stuck. Business as usual — conventional tinkering measures — will not help; we need to think on a bigger scale. Ten ideas matter in the required economic policy strategy. 

First, the oil price shock must fully pass through to the consumer. Price signals are the mechanism through which supply and demand reach an equilibrium. When prices are controlled, it introduces distortions and strains the fiscal balance. Higher prices of petroleum products will induce the necessary adjustment in both consumption and production. 

Second, the macroeconomic shock must fully pass through into the exchange rate. Attempts to manage the exchange rate harm economic growth and will prove futile. A flexible exchange rate acts as a necessary shock absorber. 

Third, Indian economic success is built upon the emergence of high-productivity firms, with a starring role for exporters and multinational corporations. These firms face an uncertain global environment and require enhanced access to finance. To navigate the age of chaos, they require full access to the global financial system to obtain low-cost capital and hedging instruments. Numerous direct-tax frictions have come to impede cross-border activities, all these require solving. Delivering this requires a comprehensive package of capital-account liberalisation. The Ministry of Finance must establish an expert committee, supported by a technical team, to design this reform package and draft the required legal instruments. 

Fourth, higher fuel prices and currency depreciation will generate inflationary pressures. Macroeconomic stability requires price stability. Economic agents are judging the institutional commitment to the 4 per cent target. A failure of the de jure macroeconomic framework will harm policy credibility for a decade. We must improve the economics capabilities in the inflation-targeting process. To build credibility, the Ministry of Finance should now narrow the tolerance band assigned to the Reserve Bank of India (RBI), shifting it from the current 2-6 per cent to a tighter 3-5 per cent. To increase the credibility of monetary policy, the RBI Act must be amended to give non-government economists the super-majority of the Monetary Policy Committee. 

Fifth, macroeconomic stability also requires fiscal prudence. General government debt surged during the pandemic and has not reverted to prior trajectories. While the current year presents difficulties for immediate fiscal consolidation, the structural path must be designed and agreed upon now. The government requires an expert committee to design a fiscal strategy through which the Budgets for 2027 and subsequent years have a sustained primary surplus of 0.5 per cent of gross domestic product (GDP). 

Sixth, firm internationalisation is essential for Indian growth. Fostering this requires deep trade agreements with members of the Organisation for Economic Cooperation and Development, excluding the US. These agreements must feature greater Indian trade liberalisation than that observed in the free-trade agreements with the European Union and United Kingdom. A reversion to the philosophy of the “bilateral investment treaty” of the 1990s is necessary. To reassure private foreign players, we require international arbitration and international tax arbitration that work. The economic nationalism and tax activism of recent years have reduced the confidence of foreign firms; this stance requires structural recalibration. 

Seventh, the indirect tax system weighs heavily on the spreadsheet of every firm evaluating an investment in India. Barriers to input tax credit have reversed the economic gains from the reform in goods and services tax (GST) in many respects: Every impediment to input tax credit within GST must be removed. GST should transition to a single rate of 10 per cent. Various indirect taxes are not refunded to Indian producers at the point of export; these must be repealed. 

Eighth, global foreign direct investment and portfolio investors have come to fear the non-standard ways of the Indian state. It is in our interests to look more like a sophisticated emerging market, rather than take an idiosyncratic approach that fluctuates. On most issues, we need to quietly hew to the median approach of 10 strong emerging markets. 

Ninth, reform requires project management and technical capacity. This government has three success stories: Inflation targeting, GST, and the Insolvency and Bankruptcy Code. These initiatives generated respect and policy credibility. We should learn more from the theory of change that worked for that period and bring these ways to attack the above eight areas of work.

Tenth, economic agents require an Indian state that is committed to the rule of law and globalisation, and charting a course out of central planning. Oddball statements can disproportionately disrupt the trust of the people who matter. Greater discipline in 

messaging is required. 

Economic agents sceptically watch the gap between words and deeds, and slowly learn to trust. The Budget speech of July 1991 generated a private investment boom only by 1995. The reforms of the Vajpayee government yielded a private investment boom only by 2003. Economic agents that matter observe the Indian state over time and only gradually allocate capital.

The author is a researcrher at XKDR Forum