Modinomics in a spot of bother as growth slows in India

India’s government presented its budget for the coming financial year to parliament on 1 February. The confidence exuded in the accompanying speech by Finance Minister Nirmala Sitharaman was astounding for the extent to which it ignores the struggling state of the Indian economy. Growth has been declining for over two years. The anticipated 5 per cent growth rate for 2020 is lower than what it was when the Modi government took charge in 2014. Inflation has lowered since then, but was already showing a mild downwards trend. India’s control over inflation has been made easier by declining international oil prices along with the slowing growth. The unemployment rate is at a 45-year high. If there is one economic indicator that invariably catches the eye of all economists — academic and professional — it is unemployment. Yet neither the growth slowdown nor high unemployment figured in Sitharaman’s speech. This likely means the government’s short-term policy will fail to address these developments that should be an immediate focus.

        These circumstances have not been imposed upon the Indian economy by external forces — there has not been an oil shock or balance of payments crisis. Exports have actually grown faster in the recent past. The causes of India’s slowing growth — by over a third in two years — must be sought from within the domestic economy and domestic policy. It is not difficult to spot the stress point. The economy’s investment rate is declining due to the unincorporated private sector. Where private investment is declining it is a safe assumption that the government should step up public investment to stimulate the economy. But the Modi government is steadfastly refusing to do so, likely out of a combination of fiscal compulsion and lack of an understanding of how economies work. The fiscal compulsion is the adherence to a glide path that would take the economy to the fiscal deficit-target of 3 per cent of GDP.

        Any chosen level of deficit may be attained by different combinations of capital and consumption spending. But the government is unwilling to cut the latter, meaning it is unable to sufficiently raise public investment when it is needed most. This explains in part the expenditure allocation in the budget, with the fiscal numbers also driven by the Modi government’s predilection — if not ideology. Prime Minister Narendra Modi is committed to neo-liberalism — the view that markets should be given a free run and government intervention should be curtailed. He has been true to his election slogan of ‘minimum government’ — repeated by the Finance Minister in her election speech — and engineered a decline in government expenditure as a share of GDP since 2014. This position has not helped shore up growth, which has taken a beating after the demonetistion in 2016. The latter had involved the public having to turn in approximately 85 per cent of the value of the currency in circulation to banks, part of which was exchanged for new notes and the rest deposited in savings accounts. The demonetisation was greatly disruptive despite the currency in circulation being quickly restored. The economy has slowed in every succeeding year since.

        Although the Finance Minister did not make any mention of the growth slowdown, she did commend the budget for its ability to stimulate growth. This claim is based on the reduction of the personal income tax rate for incomes below a threshold. But it is difficult to imagine that this would make a major impact on growth. The economic logic behind the tax cut is that it would lead to greater consumption expenditure that would raise investment by raising output. The claim is dubious for income tax-payers represent a small percentage of the total population of the country. Again, the only route to raising the investment rate when it is on the downswing is for public investment to be stepped up — which the government refuses to do. The government is stuck in an unhealthy quagmire of not wishing to lower its own consumption expenditure or be seen as cutting subsidies — the sacred  cow of Indian politics — even when the subsidies are regressive in their impact.