"The economy in the time of Narendra Modi", 'The Hindu', June 5, 2017

The economy in the time of Narendra Modi

As the Bharatiya Janata Party reportedly prepares for ‘Modifests’ to celebrate the completion of three years in power of the citizen would be interested in knowing how its government has performed in respect of the economy. This because in his election campaign in 2014 Narendra Modi had chosen to highlight his ability to turn the economy for the better, notably to raise its growth rate. Once he became prime minister he quickly presented his idea of how this could be done. Manufacturing was to be the key and ‘Make in India’ the government’s programme to actualise it. Pressing ahead to produce in India can hardly be faulted as an objective, for in a market economy income generation depends upon making something. As for the focus on manufacturing, its relevance cannot be exaggerated. Indian agriculture is overcrowded. With shrinking farm size, the returns to this activity is set to shrink and only manufacturing can absorb the labour that will have to be transferred out of agriculture. Also manufactures are often easier to export than the services that India specialises in. So, ‘Make in India’ is eminently sensible of itself. But how successful has this initiative been?

            Turning to the evidence, we would find that far from taking Indian manufacturing to new heights, performance since 2014 does not match what has been achieved in the last boom In India, which had obtained during 2003-08. During this period, for the first time in decades, manufacturing had led the  growth acceleration in the economy. In most of these years annual growth of manufacturing had exceeded 10 percent, which has not been matched since. Interestingly, the performance of this sector in the last three years is not superior even to that at the tail end of UPA II. Clearly, ‘Make in India’ is yet to fulfil its promise. Now, could it be that the programme has actually had a favourable impact but the fruits are yet to appear? This is possible, and would be the case if the programme has led to a surge in investment. But there is no evidence of this either. If we take a wider measure of investment, that for the economy as a whole, we see that capital formation as a share of total output has declined even more sharply since 2014 than it had been since the decline began in 2011. Private investment, seen as the bellwether of an economy, has not been forthcoming despite this government’s business-friendly orientation. As the decline in investment had commenced in 2011 the development itself cannot be laid at the present government’s door but it is unambiguously the case that it has not been able to reverse it. Part of the reason has to do with the feature the focus of ‘Make in India’, such as with the ease of doing business, has mostly been on the supply side. But there is demand to reckon with. Firms invest in anticipation of demand, and when they perceive slow growth of demand they are likely to hold back.

            It is clear that some part of the slow growth of demand in India is beyond the grasp of government due to the weather cycle. Two of the past three years have been years of very poor agricultural GDP growth with the figure actually negative in 2014-15. But agriculture’s performance cuts both ways, serving also as windfall for when it turns out to be buoyant. Thus, for 2016-17 the CSO’s advance estimates indicate a more than three-fold increase in agricultural growth while industry and services register a reduction in theirs. Had agricultural growth not risen so dramatically growth in 2016-17 would have slowed even more than it actually did. The government just got lucky.

            Whatever may have been the demand-constraining impact of slow agricultural growth in the first two years of this government’s tenure the independent role of its macroeconomic policy is evident.  At a time of declining private investment the prudent thing for a government to do is to raise public investment. This has not happened on anything like the scale necessary. Indeed with regard to fiscal policy the government had been guided by fiscal consolidation defined in terms of deficit reduction. Admittedly, in this the NDA II has only taken forward a programme initiated by UPA I. But the slowing of capital formation was not a feature then and economic policy is meant to respond to a changing environment. In 2016-17 gross fixed capital formation in the economy turned negative. This worrying development requires addressing. But having tied itself down to a dogmatic policy stance the government can do little. The centrepieces of this policy package are fiscal consolidation and inflation targeting. This combination leaves no room to address concerns of growth. The government’s response to suggestions that it respond to the situation is that it will not sidetrack fiscal consolidation. Actually, no one is asking it to! It is possible to adhere to fiscal deficit targets while expanding public capital. You do this by switching expenditure from consumption to investment.

            All this is from a macroeconomic point of view. To be fair to the government we must acknowledge its other programmes. Admittedly there are several but it is the demonetisation that it thinks of as its showpiece. Claims made have been the ending of corruption and tax evasion. So far we can only be certain that there was an immediate slowing of growth in the formal sector of the economy after November as reflected in the index of industrial production. It is too early to establish what the impact will be on tax revenues but it is difficult to imagine that the demonetisation will achieve more for revenues than the GST and a more efficient would have. Interestingly, in his book ‘The Curse of Cash’, the guru of the ’less cash’ movement Kenneth Rogoff presents data that show countries with a relatively high cash-to-GDP ratio, such as Japan and Switzerland, having smaller underground economies than some such as the Scandinavian ones recording ‘far far’ less cash. It may be noted that in Japan the said ratio is fifty percent higher than in India. No one thinks of Japan as backward. So, with the demonetisation, has the government caused output loss without clear gains elsewhere in the economy?  And if the argument was that large denomination notes abet corruption, it is difficult to comprehend the replacement of the one thousand rupee currency note with a two thousand rupee one. It is clear from this that politicians and economists are not daily-wage earners.

                        Prime Minister Modi is not a man for the understatement. He had come promising a transformation of the economy. Three years later the standard indicators show no sign of his government bucking the trend. It may be seen in the latest ‘Economic Survey’ that growth had began to rise and inflation to fall before 2014. Since then the growth acceleration has tapered off, with the year just ended actually recording a slowdown. Finally, in what must come as an embarrassment of sorts considering the slogan of ‘minimum government’, among the most prominent drivers of growth in the past three year has been a record growth of government consumption expenditure. The stock market however exults! Apparently the punter holds something close to his chest.