Growth risks

India needs reforms to enhance productivity

The Reserve Bank of India’s (RBI’s) Annual Report, released on Tuesday, reiterated the monetary policy committee’s assessment that gross domestic product would shrink in the current fiscal year. While economic activity is recovering with relaxation in lockdown, a substantial increase in government spending in the first quarter is likely to have provided some relief. In this context, the report rightly notes that the fiscal policy in the future is likely to be conditioned by the large debt overhang and contingent liabilities accumulated during the pandemic. A credible plan for reducing debt and deficit would be required. Thus, it would be prudent to expect a lower contribution of government expenditure in overall demand with the resumption of fiscal consolidation. This is broadly in line with former RBI governor D Subbarao’s prognosis. In a recent interview, Dr Subbarao noted that once the crisis was over, the fiscal deficit would be much higher, the debt burden would increase significantly, and the financial sector would be in worse shape.

Clearly, these factors will constrain medium-term growth after the initial bounce-back in economic activity. Thus, it is critical that calculations or expectations about the third decade of the 21st century should not assume reversion to mean, which in the last two decades has been a 7 per cent-plus rate of growth. The number is likely to be significantly less. The government should, therefore, be careful in its assumptions about the future: What is possible in terms of growth, poverty reduction, and the sustainability of a welfare system that is haphazardly being born. The government will need to do a thorough reassessment of the Budget to reorient expenditure. The implications of slower growth are important also on the strategic front, when China promises once again to become the fastest-growing economy despite its shrinking working-age population.

How can India do well when there are macroeconomic constraints? The answers lie in favourable prices, such as continued cheap oil, facilitated by slower global growth, and productivity growth through policy changes. In terms of policy changes, the government plans to build multi-modal industrial clusters and somehow make a breakthrough on the manufacturing front, aided by investment from overseas manufacturing companies that know the game. But India will also need integration into global supply chains; a new approach to industrial housing and urban management in the context of large-scale migration (one objective being to lower the cost of labour by lowering housing and transport cost); an end to power cross-subsidies, which raise energy cost for manufacturers; an end also to transport cross-subsidies, which raise the cost of freight; a transformed financial sector that delivers adequate and cheaper credit, especially to micro, small, and medium enterprises; and flexible labour policies without sacrificing worker safety nets. In the long run, productivity gains will come only with a better-educated, better-fed, and healthier population. 

India’s medium- to long-term growth to a large extent now depends on the post-Covid policy response. Tentative changes could materially bring it down. Further, India would soon need a new medium-term fiscal plan, as sustained higher deficit and debt could increase risks to economic stability and growth.