"The economy on auto pilot", 'The Hindu, September 22, 2016

The economy on autopilot

As the Narendra Modi government inches towards its half-way mark its economic philosophy stands revealed. This appears to consist of aiming at some ideal institutional architecture while leaving economic forces to play out on their own. The criterion of macroeconomic stability, defined mainly by inflation kept within a range, completes the picture. Underpinning such an approach is the premise that the potential of the economy, reflecting the chosen acts of private agents, not only cannot be improved upon by the government but its realisation could actually be stymied by intervention. This is a well-known position in the canon of Anglo-American economics tending towards the view that market outcomes are the best. The maxim ‘minimum government is maximum governance’ could legitimately claim to be its progeny.

          How, it may be asked, has this philosophy served the economy? We could start with growth. Since May 2014 growth has accelerated but at a much slower rate than that it already had commenced upon in 2013-14. India today is the world’s fastest growing economy but this we owe to the fact that China has slowed more than India has. India has not exactly surged into number one position. But more importantly, the government has not so far been able to achieve the substantial quickening of the economy that Mr. Modi had promised at election time. The government has on occasion extolled its record in maintaining macroeconomic stability. This is indeed correct. Inflation has declined but this only reflects a downward trend that had started in 2013-14. The government would also no doubt like to take credit for sticking to the pre-announced fiscal consolidation path. The fiscal deficit has steadily declined since May 2014. The Finance Minister’s public statements suggest that he treats this as a significant achievement of his government. Actually, it typifies the search for the ideal architecture without sufficient concern for outcomes. The truth is that this government had inherited an economy with quite rapidly accelerating growth and steadily declining inflation. It has barely managed to maintain this scenario. The promised resurgence has not materialised.   

          It is with respect to investment that the government’s record is uninspiring. Far from having been able to instil confidence among private investors, the government has been unable to stem a decline in capital formation - as a share of output - in progress for at least half a decade. On its part the government takes recourse to the figures on foreign direct investment (FDI) to signal the effectiveness of its policies. Data from the Department of Industrial Policy and Promotion show that in the year just passed the economy attracted increased FDI upto 29 percent in dollar terms. While this is impressive, and to be welcomed, it is important to have a sense of what it amounts to. In the year 2014-15 FDI amounted to a mere 4 percent of total capital formation in India. So, while FDI is to be encouraged, its ability to make a significant contribution to growth is limited. On the other hand, over seventy five percent of capital formation is undertaken by the domestic private sector. Any significant change in the investment scenario would depend upon the actions of this segment.

          Right now private investment is very likely being restrained by the weak balance sheet of firms. The flip side of this is the high level of NPAs of the public commercial banks. Forcing these banks to lend would be poor policy. But it is not clear whether everything that can be done to lower the lending rate is being done. After all, cpi inflation, the RBI’s preferred inflation index, is trending downward and there is a case for lowering lending rates. But the RBI has now been put into the straitjacket of inflation targeting and can no longer respond to considerations of output. This leaves fiscal policy as the only instrument with the government. But the government is reluctant to use it to increase aggregate demand for fear of deviating from its fiscal consolidation path. It is of course possible to step up public investment by trimming subsidies. Here the NDA government’s approach is cravenly political, and no different from that of its predecessor the UPA. It is reluctant to be seen as cutting subsidies even when it is clear that a rupee-for-rupee a swap in certain subsidies for public capital formation is likely to be beneficial for both growth and welfare. The fertiliser subsidy presents the most obvious instance. It has done little to stem the rise in food prices while continuing to take-up precious fiscal space. There is a strong case for reviewing its continuation, at least in the present form. Well-designed empirical research alone can settle the matter of its desirability, and one hopes the government will provide this in time for its third annual budget.

          An object of this government’s admiration have been revealed to us in the choice of speaker for the first NITI Aayog Lecture on Transforming India. It chose Tharman Shanmugaratnam the Deputy Prime Minister of Singapore who was earlier its Finance Minister for close to a decade. A trained economist with considerable international exposure Mr. Shanmugaratnam typifies the Singapore model, which recognises the value of high human capital in its leadership, something that India has not seen since the time of Jawaharlal Nehru. Prime Minister Modi is right to have invited this global leader to participate in a brainstorming on how to transform India, thus drawing much needed attention to the achievements of Singapore. Though its cultural policies may not be to everyone’s taste, the economic transformation that this tiny state has so quickly wrought are most impressive indeed. There is an astounding presence there of public capital in the form of infrastructure, the most egregious of which is public housing which hosts over 80 percent of the population. Along with its approach to political freedoms Singapore’s record is closer to that of socialist planning rather than free-market capitalism. Its government has not hesitated to intervene in the economy but its interventions have been made with a finesse that has yielded substantial returns. It is ironic that a government that had so ceremoniously replaced the Planning Commission must simultaneously seek clues from the history of a country transformed by economic planning.          

          There is one specific area in which our own government may learn from the Singapore experience. The government there had instituted a provident fund to which all workers and employees have had to contribute. These contributions ensured a rise in the saving rate which in turn was a source of funding for public investment. In the muddled discourse on fiscal policy in India today the reigning argument appears to be that a fixed private saving rate sets the limit for the attainable fiscal deficit. This overlooks the possibility of raising the private saving rate, which is precisely what the Singapore government had done early in its history, enabling it to achieve a scale of public capital formation that truly distinguishes it from India. All indications are that the present government of India is striving to replicate Singapore’s institutional architecture, as in laws governing business, rather than the transformative role of public investment that turned a fishing village into a global destination for FDI. What other conclusion can be drawn from the fact that in the budget for 2016-17 the increase in the allocation for capital expenditure amounted to a mere 2.3 percent, with inflation running at around 4 percent per annum?

          A sector that is unlikely to be well served by the philosophy than an economy left to its own devices will achieve its potential is agriculture. Three of the past five years in India have been years of poor agricultural performance, reflected in a persistent food price inflation. We are very likely witnessing creeping climate change with direct consequences for production. The advisory from most funds in the financial sector is that the economic outlook this year will depend upon the monsoon. It is surprising that the imperative of drought-proofing an increasingly vulnerable Indian agriculture hardly figures in the public discourse on the economy when it is of no less importance than rolling out the GST. Nothing short of a transformation akin to the Green Revolution can achieve this, and the states would have to be on board. The present government has had little to say on the matter so far. By disbanding the Planning Commission the Centre has lost a long-standing conduit to the states whose planning boards did have at least a titular connection to the former.