Economic challenges facing the New government

Co-authored with Prof. Charan Singh, IIMB

  The new government at the Center will be facing many economic challenges in reviving economy and generating employment as economic indicators are not very encouraging.  The general index of industrial production for the month of March 2014 is lower by 0.5 per cent as compared to March 2013. The industries suffering significant decline are manufacturing followed by mining.  In manufacturing sector, 12 out of 22 industry groups have shown negative growth in March 2014 as compared to March 2013.  As per use-based classification, capital goods have recorded negative growth of 3.7 per cent during 2013-14. The index of consumer goods, especially consumer durables is also lower than March 2013. 

     The other important indicator, is the price level. Consumer Price Index (CPI), at 8.59 percent for April 2014 released recently has also shown rising trend as compared to 8.31 percent for March 2014. The inflation rate for rural and urban areas has also been high over the corresponding period.  The rise in CPI is mainly because of milk and milk product, fruits and vegetables, cereal and cereal products, and clothing and bedding.  The combined weightage of these items is more than 33 per cent of the total, in CPI.  There is also significant state-wise variation in inflation as measured by the CPI. Illustratively, Tripura records 20.1 percent inflation while Manipur of 5.3 percent.  The Wholesale Price Index, shows a moderate rate of inflation at 5.20 percent for April 2014 but the stress points continue to be cereals, fruits, milk, egg, meat and fish, and potatoes.

     On fiscal front, in general, India has been recording a gross fiscal deficit of 4.5 per cent and above for the last few years.  Though in 2013-14, according to revised estimates, the ballooning deficit has been contained at 4.6 percent, the quality of fiscal adjustment needs improvement.  Gross tax revenue has recorded a short-fall, mainly on the account of lower collections under indirect taxes consequent to industrial slow-down, lower imports and lower growth in services.  Also a sharp cut down in Plan expenditure, particularly on revenue account, has been recorded.  There has been sharp increase in subsidies especially on account of Food security bill but other non-Plan expenditure has been curtained under the fiscal austerity drive. 

    In view of the global situation as well as research at the RBI, real GDP growth is projected to be around 5.5 per cent in 2013-14.  In view of the economic trend globally, sustained revival in industries, exports and services does not look likely.  In view of the El-Nino effect, prospects of a bumper agriculture are also not very bright. The government has been announcing series of measures since the Interim Union Budget in February 2014, some of which like setting-up of 7^th pay commission impact expectations and therefore have inflationary implications. The general elections have also involved significantly large expenditure on part of the government as well as the potential candidates which imply pumping money, some of it probably even black money, in the economy.  All these economic factors will have implications on inflationary pressures in the economy.  As inflation continues to be high, the interest rates would also follow a tight trajectory.  In its Annual Monetary Statement on April 1, the RBI had observed that CPI inflation would be 8 per cent by Jan 2015 and if inflation continued along the intended path, further policy tightening may not be anticipated. However, given the inflationary situation as it is evolving, it is not anticipated that interest rates would be lowered in near future with consequences on investment and growth unless the government announces special measures. 

      Another significant challenge that the Indian economy will face is the current account deficit (CAD).  In India, CAD continues to be the within the limit because of excessive control over imports, especially gold.  The new government could relax restrictions on gold which could again place stress on CAD.  The unwinding of the unconventional monetary policy by the US, could also have an impact on CAD.  Finally the urge to have a stronger rupee against the US dollar, as evidenced in the last few days, could lower exports and encourage imports.

     If the new government is seeking to raise the growth level to 8 per cent and above, besides economic measures, it would be necessary to establish credibility by announcing appropriate fiscal measures.  The Fiscal responsibility Bill has been placed in the cold storage for some time, which will have to be revived to establish credibility of India in the minds of global analysts.  The need to improve tax administration and hopefully the Goods and Service Tax and the Direct Tax Code will help improve tax collection.  There is also a need to undertake reforms in subsidies, especially food, fuel and fertilizers.  There is also an urgent need to address structural challenges in the energy sector as well as in the agricultural sector. To directly address the challenge of creating employment, especially in the short run, it will be useful to focus on micro, small and medium enterprises. These measures are important for increasing growth in the economy in immediate future.

A version of this Article appeared in The Financial Express in 17, May 2014 under the banner, “A Rush of Reforms Needed”. http://epaper.financialexpress.com/c/2851294 .