The harsh lockdown in Mar 20 flattened the economy. The Rs 20 lac crore package announced by the PM was a fraud. What harm has been caused cannot be undone. I have not written about the economy for quite some time. It is time to take a holistic view of the economy to assess the efficacy of the policy measures taken by the government as well as RBI and suggest a roadmap for improvement of the economy for the benefit of my students and all those who take out their valuable time to read what I write.
World Economic Prospects
According to the “World Economic Situation and Prospects” as of mid-2020, the growth rate of India has been projected to grow at 1.2% in fiscal year 2020. The report has indicated a slight recovery in the growth rate of India for fiscal year 2021 and stated that it would clock a 5.5% growth rate in 2021. The UN has projected that the global economy will contract sharply by 3.2% in fiscal year 2020, with only a gradual recovery of lost output projected for fiscal year 2021.
Consumer demand has been crushed, and savings are rising in an unprecedented manner. This seems likely to have long-lasting effects on financial markets, depressing interest rates for years.
The personal saving rate in US touched 33% in April. In the Eurozone, the household-saving ratio is expected to rise from 13% to around 19% this year and remain at historically high levels into 2021.
Global demand is subdued and likely to remain so in 2021, thus India can avail cheap credit but cannot expect a rise in exports.
Covid-19 lowered China’s global image. Businesses did move out of China but not to India but primarily Vietnam and other Southeast Asian countries because India is not an attractive investment destination.
Economic Situation Prior to Covid-19
GDP and Unemployment
The mismanagement of the economy by a corrupt and incompetent government had resulted in the GDP falling to a record low of 4.2 percent and the unemployment rate had risen to a record high in 45 years before the arrival of Covid-19.
Delayed Action to Prevent Spread of Covid-19
Modi government was focused on toppling the MP government and ‘Namaste Trump’ event and hence delayed institution of checks to prevent the spread of Covid-19, which should have been initiated in Feb 20.
The lockdown, when the history of Modi’s misrule is written, will rank along with the ill planned demonetization and GST as a major disastrous step in ruining India’s economy. It resulted in a loss of approximately Rs 10-12 lac crore. It did not prevent the spread of Covid-19, caused immense hardships to all Indians, particularly the poor and migrant labourers. The most appropriate comments came from Rajiv Bajaj, a rare corporate man who has the courage to speak the truth when he said about the lockdown, “It flattened the wrong curve.”
Prashant Bhushan has filed a PIL against the government for the handling of Covid 19 crisis. In his words it is, “gross mismanagement at many levels. It’s so serious and so negligent it borders on the criminal”
Efficacy of Steps Taken by Government
- Micro, small and medium Enterprises (MSMEs) are the growth accelerators of the Indian economy, contributing about 30% of the country’s gross domestic product (GDP). In terms of exports, they are an integral part of the supply chain and contribute about 40% of the overall exports. MSMEs also play an important role in employment generation, as they employ about 11 crore people.
- Rs 3 lac crore guarantee was announced for MSMEs by the government.
- The government has amended the General Financial Rules 2017 to disallow global tenders in government procurement up to `200 crore, as announced in the Aatmanirbhar Bharat package’. This step is expected to create more opportunities for domestic players and will allow the local industry to gain from this initiative.
Credit to MSMEs shrank up to 7.6% between March and May 2020 as the lockdown brought economic activity to a halt. In the absence of demand MSMEs are not borrowing to restart or grow further.
An additional amount of Rs 40,000 crore was released during Covid-19 crisis. The earlier allocation was Rs 60,000 crore. Even this financial year began with pending wage and material liabilities of Rs 16,045 crore. An allocation of Rs 1 lakh crore meant that approximately Rs 84,000 crore is available for employment generation this year. This will still be the highest allocation for MGNREGA in any year since the passage of the law.
The allocation, which amounts to 0.47 per cent of the GDP continues to be much lower than the World Bank recommendations of 1.7 per cent for the optimal functioning of the program. It has been helpful to the rural poor as also a portion of the migrant labourers, who reached their homes in villages from urban centres.
1.7 lac Crore Relief Package
The much needed relief package did help in the survival of lacs of people. It, however, did not raise demand in any significant manner.
- Protests. Farmers protested against the three ordinances– The Farmers’ Produce Trade and Commerce (Promotion and Facilitation) Ordinance, 2020, The Farmers (Empowerment and Protection) Agreement on Price Assurance and Farm Services Ordinance, 2020 and The Essential Commodities (Amendment) Ordinance, 2020.
- Comments: These so called ‘reforms’ have done no good to the farmers at present. We can only hope that these would do well in the long run.
- March 27: Announces repo rate cut by 75 basis points, reduction in CRR by 100 basis points, Long Term Repo Operations (LTRO) to infuse Rs 1 lakh crore liquidity and other measures after first Monetary Policy Committee (MPC) meet following the pandemic announced a three-month moratorium on all loan repayments till May 31
- April 3: Reduced daily money market trading time to four hours from 10 am to 2 pm
- April 17: Cut reverse repo rate by 25 basis points and other measures.
Announced a special finance facility of Rs 50,000 crore for Nabard, Sidbi and National Housing Bank, targeted LTRO of Rs 50,000 crore and changes in NPA classification to exclude the 90-day moratorium period.
- April 27: Announced a Rs 50,000 crore special liquidity facility for mutual funds.
- May 22: Announced repo rate cut by another 40 basis points after second MPC meet. Extended the three-month moratorium on repayment of loans to banks by another three months till August 31.
- The MPC kept repo rate at 4 per cent in August.
I have been a critic of RBI Governor and the functioning of RBI since the change of the board and appointment of Das as the Governor. However, I cannot fault the actions of the RBI during the period. I would like to quote Deputy Governor and MPC Member Michael Patra, “Disappointingly, inflation and surprises of recent months are undermining the MPC’s actions and stymieing its resolve to do what it takes to revive growth and mitigate the impact of COVID-19 on the economy.”
Oil Price Hike
The negative impact on the broader economy will be severe. This is because state governments are also increasing VAT regularly. For example, petrol and diesel prices in Delhi increased by Rs 1.67 and Rs 7.10 respectively after the Delhi government hiked VAT on fuel. India charges the maximum tax on petrol and diesel and this makes oil consuming sectors less competitive compared to other countries. These are forced to pay more even as competitors in other countries get the same fuel for less.
- China is India’s second-largest trading partner after the US. It accounts for nearly 12% of India’s imports across sectors such as chemicals, automotive components, consumer electronics and pharmaceuticals. “At least 70% of India’s drug intermediary needs are fulfilled by China,” Sudarshan Jain, president of the Indian Pharmaceutical Alliance, told the BBC. Although India has announced a new policy to become more self-reliant in drugs, he says that will take time.
- India’s booming smartphone sector also heavily depends on cheap Chinese phones made by Oppo, Xiaomi and others with the lion’s share of the local market. Most consumer electronics makers say they will be paralysed if they cannot import crucial intermediate goods from China.
- “We are not worried about finished goods. But most players across the globe import key components such as compressors from China,” says B Thiagrajan, managing director of Blue Star Limited, an Indian manufacturer of air conditioners, air purifiers and water coolers. Mr He adds that it will take a long time to set up local supply chains, and that there are few alternatives for certain kinds of imports.
- China Funds Indian Unicorns
o India and China have become increasingly integrated in recent years. Chinese money, for instance, has penetrated India’s technology sector, with companies like Alibaba and Tencent strategically pumping in billions of dollars into Indian startups such as Zomato, Paytm, Big Basket and Ola. This has led to Chinese giants deeply “embedding themselves” in India’s socio-economic and technology ecosystem,
according to Gateway House, a Mumbai-based think tank.
- “There have been more than 90 Chinese investments in Indian startups, most of them made over the last five years. Eighteen out of 30 Indian unicorns [tech startups valued at over $1bn] have a Chinese investor,” says Amit Bhandari, an analyst at Gateway house.
o India’s domestic manufacturing sector can substitute as much as 25% of total imports from China, according to new findings from Acuité, a ratings agency. This would lead to a reduced import bill of over $8bn in a single year.
o Handicrafts, for instance, is a category where India imported $431m worth of goods from China in the 2020 financial year without any significant reciprocal exports.
o From India’s standpoint, none of this is likely to play out without grave consequences to the economy, especially during a severe downturn. China, on the other hand, is less concerned since India accounts for only 3% of its exports.
o So far Beijing has been restrained in its reaction to the growing backlash in India.
o A recent op-ed in the daily Global Times warned that “China’s restraint is not weakness”. It says it would “be extremely dangerous for India to allow anti-China groups to stir public opinion, thus escalating tensions”, and adds that the focus should instead be on “economic recovery”.
o Coming back to the notion of self-sufficiency and self-reliance is a very old idea. As much as these are desirable goals, in the modern economy, they are often either not achievable or achievable in a counter-productive manner. Let us take an example. India is very proud of its self-sufficiency in food grains. When it comes to fertilisers, which is arguably the most important input towards achieving self-sufficiency in food grains, India is not self-sufficient. This is true for all the main fertilisers — Urea, Phosphorus and Potassium. Worse, in all likelihood, India would never be. At present, India imports two-thirds of its requirement for fertilisers. Diverting all domestic natural gas to fertilisers would come at the cost of power generation, CNG etc.
o This unplanned and sudden move, like most of Modi’s actions, towards self-reliance will come at the cost of consumers, who will have to either pay more for an Indian alternative or make do with a less efficient Indian alternatives instead of enjoying the best products at the lowest prices possible. In that sense, as things stand, this policy, like many in India’s long past, simply robs the consumers to pay the producers, who tend to be better at lobbying for their interests than being globally competitive.
o In the months ahead, we hope to see concrete policy steps towards achieving the goal of ‘Atmanirbhar’ because without them, this initiative is likely to be fail like the “Make in India” initiative. I worry that this step does not set back India’s economic growth the way the first wave of economic nationalism did immediately after Independence.
Present State of Economy
The GDP growth before the lockdown was 4.2%. As per RBI it is expected to go in the negative.
Domestic demand accounts for about 58% of our GDP. This is in a bad state. No sincere efforts have been made by the government to raise demand.
I could not get any worthwhile information from an authorised source on the subject.
Household financial liabilities had fallen to 2.9% of gross national disposable income in 2019-20 from 4% in 2018-19 even before Covid-19. It would have fallen even lower now. On the investment side, the prospects of a pick-up in the private sector capex cycle also appear to be bleak. Companies have utilised the cash flow freed up due to the reduction in the corporate tax rates to meet their loan obligations, and to build up their cash reserves, indicating limited appetite for launching fresh investment.
o IT. India’s growth story has been driven by services, which has a 55 per cent share in the economy. India is fast becoming a major quality service provider. Before COVID the sector was booming. The widely-tracked Nikkei India PMI Index stood at 57.5 in February, up from 55.5 in January. However, IHS Markit India Services Index reports that the services sector has been contracting for five consecutive months since March, with an index of 34.2. In PMI jargon, the 50-mark level separates expansion from contraction. Given the uncertainty in the world market and the projected slowdown of developed economies by 8 per cent this year, India’s services-led growth has to depend mostly on the domestic economy.
o Tourism. The tourism industry, which contributed nearly 10 per cent of GDP, is now witnessing a large-scale reduction in jobs and operating returns have plummeted to 10 per cent of previous revenues for most.
o Aviation. If the Centre for Aviation is to be believed, the aviation sector is expected to have lost $3.6 billion in the three months leading up to June. The number of potential job losses in the sector gives an even harder jolt to an already dwindling economy. After holding rounds of meetings with industry representatives and making several references to its condition in speeches, the government is not aloof from the catastrophic consequences suffered by the sector.
o From tourism, aviation, shipping, space to call centres and delivery services, the standstill in activities is bound to have a knock-out effect on employment, production and the economy as a whole. The big picture suggests that the current relief provisions for the primary and secondary sectors would also be nullified as a consequence of neglecting the tertiary sector.
o An immunity-building exercise through capital infusion and appropriate relaxation in relevant sectors will help the economy to survive the pandemic. Most of the services sectors are the worst affected and unfortunately, we do not see any specific fiscal and monetary stimulus for them. In fact, some sectors would find it difficult to survive if the pandemic continues.
The sector contributes over 16% of our GDP. It is in a bad state.
The measures taken have not delivered results.
It is the lone bright spot. Agriculture GDP is set to have a positive growth, thanks to good monsoon rains.
Imports/exports are both down. The prospects of exports picking up are bleak.
Bank credit growth is likely to nosedive to a multi-decadal low of 0-1 per cent in 2020-21. non-food credit growth decelerated to 6.8 per cent year-on-year from 11.4 per cent in the corresponding period of the previous year.
Bank loan growth to industry decelerated to 1.7 per cent in May from 6.4 per cent in the corresponding month last year.
Loan growth to the services sector slowed down to 11.2 per cent in May, compared with 14.8 per cent a year ago.
Personal loans growth decelerated to 10.6 per cent in May 2020, against 16.9 per cent in May 2019.The ratio of gross NPAs may rise to 12.5% by March next year, in a baseline scenario. The central bank’s Financial Stability report (FSR), noted the NPA ratio could jump to as high a level as 14.7% in the event of severe stress.
Rain and Oil Price
Two major influences in Indian economy are monsoon rains and oil prices. Fortunately for us rains have been good and oil prices are low. To tide over the grim situation we need to act in a decisive manner, which apparently the government seems disinclined or incompetent to do.
India should not be bothered about increasing fiscal deficit up to 14% of GDP. It should be funded by printing money and foreign borrowing. This will be vital to save lives, create jobs as well as infrastructure.
The government should work in the spirit of federalism and decentralisation. GST dues of the states must be paid quickly. The plan to make the states borrow via RBI is incorrect. The borrowing of approximately Rs 3 lac crore should be done by the centre and honour the promise made. The centre should pay the price for mismanagement of the economy & not the states.
o Cash. Demand has to be increased and the extremely poor kept alive. Cash should be given to the poor at the rate of Rs 25,000 per each family.
o Infrastructure/ Jobs/Money. A McKinsey report has advised that India needs to create 9 crore non-farm jobs in the coming 10 years. To do so India needs to spend at least Rs 3 lac crore on valuable infrastructure (not projects like Central Vista). This will have a multiplier effect by generating demand for construction material, creating jobs and generating incomes.
o IncomeTax. Income tax must be drastically cut down. This will increase disposable income and generate demand.
The government should establish an all- party committee to plan and implement genuine agriculture reforms, unlike the unilateral ones passed through the recent ordinances.
The government should establish an all- party committee to plan and implement genuine MSME reforms to include fiscal measures because monetary measures in the current situation have failed.
Taxes on Oil
The extremely high taxes on oil should be eliminated. This will help reduce inflation and provide room for reduction in interest rates and provide greater competitiveness to Indian industry.
In the short run, the government needs to make cuts in VAT, which ranges from 0-30 per cent on aviation fuel, make provisions for GST holidays, compensate for wages of workers under distress and draft flexible terms for working capital credit.
The government should establish an all- party committee to plan and implement a practical long term plan for Atmanirbhar Bharat. It should not be a bunch of knee jerk actions which cause more harm than good.
The government should establish an all- party committee to plan the eradication of NPAs and banking frauds which are ever increasing. Greater autonomy should be provided to the banks. At present the global interest rates are low and India should take advantage of this to borrow money from abroad and utilize it for infrastructure creation/jobs and demand.
The allotment should be kept open ended. It may need another Rs 1 lac crore.
Terminate Divisive Agenda, Corruption and Improve Democracy
The government should stop the divisive agenda, cancel the CAA, restore Article 370 & 35 A, cancel the electoral bonds scheme and PM CARES fund and stop erosion of democracy. The PM should take some action on his promise of “Na khaunga, na khane doonga” because there is far too much corruption by Modi government which is promoting the frauds and allowing the fraudsters to run away.
I only hope the government pays heed to at least some of the above ideas and brings India out of the self-created mess. The expected harsh truth is that the government may do nothing of the above. India should prepare itself for continued long term massive unemployment, rise in poverty, suicides, deaths and people being forced into a life of crime because the economy is likely to be run by the ‘raw wisdom’ of PM Modi, the results of which we have been suffering so far.