India Economic Survey 2015-16: Creating Opportunity and Reducing Vulnerability

Decisive reforms can put India on a double-digit growth trajectory. So, what ails the economy and what must be done to heal it?

Introduction

• Growth, a prerequisite for achieving many economic and social objectives. Thus, government actions should aim to maximize the benefits and create opportunities for all sections of the society
• Three-pronged strategy – promoting competition and investment human capital, and reforms in agriculture required to achieve double-digit growth trajectory
• State and entrepreneurial capacity determine the ability of a country to grow over long run. Since there is fundamental asymmetry between economic development and institutional quality, outlier countries such as India and China will eventually revert to the mean

Macroeconomic Outlook and Prospects

Recalibrate growth expectations and initiate gradual fiscal consolidation given the changed realities of the world economy….

• GDP growth for FY17 to be around ~7 – 7.75%, wider range reflects extreme possibilities – from a rebound in agriculture to a full-fledged international crisis
• Deflationary impulses from abroad, currency readjustment, extreme financial events leading to sudden stops, spike in crude prices are some of the potential external risks
• Gradual fiscal consolidation will provide economic stability along with providing insurance against growth slowdown 
• In light of weak external environment, need to activate all domestic sources of demand to prevent the growth momentum from weakening

Twin balance-sheet problem (TBS), the holy grail….? 

• Large and rising stressed assets in the banking sector coupled with declining profitability and worsening indebtedness of corporates pose risk
• Resolving the TBS challenge requires 4 R’s: Recognition, Recapitalization, Resolution, and Reform
• Given stretched government finances, either government could sell off some of its assets or RBI could deploy its own capital to partly recapitalize public sector banks as it has enough legroom to do so
• Weak corporate balance sheets, stretched banking system, and difficulties in exit has triggered a massive underinvestment cycle in the economy. So, until private investment revives, public investment, especially by the railways, ought to play a catalytic role

Structural Reforms

Reverse jobless growth….

• Economic active population at ~63%, asymmetric growth (i.e. jobless growth) unsustainable considering the demographic profile of the country
• Focus on boosting labour intensive manufacturing address the pressing labour market challenge
• Centre should promote dynamic of competitive federalism where states compete for more jobs

Augmenting entrepreneurial capacity by addressing the 'Chakravyuha' or exit challenge….

• India moved from socialism with limited entry barriers to marketism without exit 
• Due to lack of exit option, far too many inefficient firms operate in the Indian economy than in a well-run capitalist economy (e.g. fertilizer industry, public sector banks and enterprises, discoms, private sector companies particularly infrastructure etc.). A 40-year old plant in the US is 8 times as large as a new one while this number is a mere 1.5 for India. 
• Exit valuation for the investors in technology-enabled start-ups still remains low, expected to increase as the impact of new SEBI policies on listings comes into effect and as equity markets, in general, revive.
• The problem of exit paradoxically arises from a combination of both weak and strong institutions (e.g. investigative/referee institutions).
• New bankruptcy law, rehabilitation of stalled projects, proposed changes in the anti-corruption law, and many other reform proposals are meant to break this ‘Chakravyuha’. The possibilities of exit from various types of deadlocks could lead to greater allocative efficiency in the Indian economy 

Rainbow revolution, expansion in irrigation facilities and grater market integration to improve incomes and productivity in agriculture….

• Availability of Pulses, main source of protein for Indians, has declined from 60 gram in 1960s to 47 grams in 2000s
• Rainbow revolution – move away from cereal-centric crops to pulses & oilseeds to match changing diets patterns – will require favourable MSP and procurement system
• Expansion in irrigation facilities and efficient micro-irrigation technologies for efficient water use and increased productivity – more from less
• Greater market integration in agriculture essential to ensure higher farm gate prices for farmers

Provide subsidy based on social instead of private returns to stop exploitation of resources and curb leakages…

• Due to electricity subsidy for farmers, excessive ground water exploitation in agriculture leading to reduction in water table by a foot/year
• Almost 80% of small farmers buy urea at prices 50% higher than administered price. Only 35% goes to small farmers, rest is diverted to rich farmers/inefficient firms or leaked
• Decontrol urea imports to foster competition, give producers subsidy in proportion to the nutrient content of fertilizers and implement MNREGS and fertilizer subsidy through JAM platform to curb leakages. 

Complex regulations in power and labour markets leading to loss of international competitiveness….

• Complex tariff structure for power, one price for petroleum but 100 prices for power
• Tariff and non-price regulations impeding unified market for power sector
• Cross-subsidy to poor power consumers ought to be financed by overcharging rich individual consumers instead of industry
• Excessive legal hassles in employment contracts of workers in registered firms has resulted in massive substitution of contract workers for regular workers, moved employment to unregistered firms, and destroyed international competitiveness in labour-intensive industries such as garments

Undertake measures to boost trade….

• Contraction in global trade has taken away a sizeable chunk of India’s growth, plethora of schemes – Merchandise Export from India scheme (MEIS), Service Export from India scheme (SEIS) and incentives for SEZs have been introduced
• Under FTPs, government has sought to bring down the extent of documentation and paperwork with greater focus on use of electronic means for trade facilitation

Free Trade Agreements (FTAs) require reassessment....

• Analytical and other preparatory work must begin in earnest to prepare India for a mega-regional world
• Need through analysis of export sector and relook at the FTA regime that has increased trade but at the cost of higher imports than exports because the country has had to go for larger tariff reductions than its partners
• FTAs, if pursued in future, must be combined with strengthening of India’s ability to respond with measures consistent with the World Trade Organization (e.g. anti-dumping and conventional duties and safeguard measures)
• In light of India’s increased competitiveness in agriculture, country could consider a shift away from protection (i.e. reductions in its high tariff bindings) to providing greater support for its farmers at the WTO negotiations
• India could cede some ground with respect to its demand for special safeguard measures – the right to impose trade barriers in case of a surge in farm imports – because it only needs it for a small fraction of tariff lines (e.g. milk, dairy, fruits and raw hides). 

Strengthen the State

Recalibrate fiscal relations with rich and poor….

• India is not an under-taxed or underspending economy once you control for its level of development
• But low number of tax-payers inhibit strong fiscal position of state, ratio of taxpayers to population is ~ 4% instead of ideal 23%. Thus, should be no further increase in exemption limits
• Rising inequalities due to growing concentration of incomes at the top decile, rich disproportionately receive implicit subsidies to the tune of Rs ~1000 bn on railways, electricity, LPG, Gold, ATF, small savings. Levy Robin Hood taxes on rich regardless of source of income and on property
• Build legitimacy in state by delivering public goods for all, reduce bounties for well-off, they are ones who advantage most from tax benefits (e.g. mandatory deductions from employee salaries higher for poor than rich, ~15% vs 0.5%)
• Large returns on early life investments in mother and child, effective interventions include providing nutrition to pregnant mothers, encouraging Swachh Bharat and changing social norms and behaviour
• Wiping every tear from every eye; requires well-functioning, well-targeted and leakage-proof safety net across India’s economy. Last mile connectivity in JAM platform remains an issue (e.g. poor distribution network hinders transfer of money from banks into beneficiaries’ hands in rural India)
• Centre should incentivize states by sharing fiscal saving from DBT to help fully implement JAM. 

Conclusion

The whole is greater than the sum of the parts….

• Last year’s survey stressed on cooperative federalism and incremental reforms and number of individually incremental but collectively meaningful reforms have been enacted
• GST, strategic disinvestments, twin balance sheet problem, subsidy rationalization are pending agenda for the upcoming fiscal year
• Increased spending from higher wages and allowances of government workers post 7th CPC implementation and improved rural incomes (due to strong likelihood normal monsoon) will continue to sustain strong domestic consumption
• The promise of India depends on accelerated structural reforms at the Centre, competitive federalism at state level and good economics becoming good politics across India