Policy Response to Growth Slowdown 2019

Q 1. What is the real Economic Growth likely to be in 2019-20? Is there a trend decline or structural slowdown in GDP growth?

Answer 1:  GDP growth is likely to be 6.5% +/- 0.5% in 2019-20. This is a trend decline from the 7.5%+/-0.5% growth trajectory which prevailed earlier. It can be higher (7%+/-0.5%) in 2020-21, if there are sufficient policy reforms to put it back on an upward trajectory!

Q 2 What are the underlying Reasons for this slow-down?

Answer 2: The underlying structural reasons for the slowdown are,

(i)                  A Creeping hollowing out of the credit system driven by Government misuse of Public Sector Banks & political interference in Money-credit system: The termite ridden structure collapsed when tighter regulatory & reporting norms were imposed on banks and deposit taking NBFCs, and Indian Bankruptcy Code was approved and implemented, ending irresponsible lending by banks and irresponsible borrowing by firms.  The entire legacy costs have unfortunately to be borne by the post IBC economy.

(ii)                Dysfunctional Policies for Crop Agriculture: Wheat-Sugar-Rice agriculture has reached a Dead-end, as have half century old policies to promote & protect it. Vested interests & ignorant policy makers (Agriculture is a State subject) refuse to abandon the failed paradigm and try a new policy framework which has succeeded in many countries!

(iii)              Economic Damage from (Moral) Success in Reduction of black money. The collateral economic damage from, (a) Black money Crusade, consisting of a series of anti-black money laws, rules and actions culminating in big bang demonetization, and (b) An un-necessarily complex GST, which led to very low buy-in by informal trade & SSIs. Together these have reduced demand from informal sector significantly.

(iv)              Loss of Credibility of Union Govt with respect to growth enhancing policy reforms. One key element of this is ad hoc increases in Cesses, surcharges, sources of income(e.g. Capital gains), marginal Income tax rates and Import Tariffs, unconnected with tax economics (e.g. Direct Tax Code), combined with an excruciatingly slow pace of fulfillment of promises on Corporate tax reform(rate reduction).

Q3. What is the inflation rate likely to be, that will ultimately impact the real GDP growth rate?

Answer 3: The Global problem is no longer high inflation, but the opposite. World is likely entering another deflationary phase, which won't be as bad as the post Global Financial (2008) deflation, but needs to be recognized & accounted for in policy formulation.

Q4.  Is there a cyclical downturn in demand.  Should fiscal consolidation be forgotten, so as to stimulate effective Demand.

Answer 4: To the extent there is cyclical reduction in aggregate demand, a slowdown in GDP growth will reduce tax collections and act as a natural stabilizer. As far as deliberate relaxation of fiscal deficit targets is concerned the impact depends whether its due to Revenue or Capital Expenditure or due to new Tax Incentives or temporary tax reductions associated with tax Reforms. The impact of fiscal deficits on economy is very different coming from different sources. Higher Fiscal deficits to disguise Govt inefficiency and waste are unacceptable as they constrain monetary policy.

  Regulatory changes such as the shift from BS 4 to BS6 norms effective April 2020 and more stringent safety, insurance and other norms seems to have led to an increase in costs and a reduction in demand for cars & other automobiles.[i] Because automobile sector is such an important part of the industrial sector, a short term reduction in GST (till march 2020) on the most severely affected segments of the auto industry can, however be considered.    

Q 5.  What should the Government do about public expenditure What should be done towards rationalizing Centrally Sponsored Schemes?

Answer 5: The negative effects of any increase in revenue expenditure will have a negative effect on economy by constraining MPC’s speed of Repo rate reduction. At this point of time there is no obvious gains from increased capital expenditure and much more from reviving Private-Public Partnership Model through reform of the PP framework to bring in more capital with the same amount of public expenditure.  There is also a need for a drastic reduction in the Centrally Sponsored Schemes relating to Concurrent and State lists of the Constitution to a maximum of one scheme per Sector. Any CSS in State list should be focused on incentivizing reform & modernization, for instance reform of the technology & management systems of the Police (e.g. Forensic labs) & courts/judiciary.

Q 6. What is the direct tax reform agenda?

Answer 6: Propose new Direct Tax Code in next budget, put a draft out for public discussion as soon as possible, Corporate Income tax - reduce to 25% in next budget and to 20-22% in subsequent 3 budgets.

Q 7. What is the path ahead for GST?

Answer 7: Target a Three Tier system by April 2022, The lowest tier of exempt Goods & services is largely in place. The highest tier of surcharges is also in place, but the number of goods and service within it should be limited to 6-9. The Middle tier should work towards a single standard rate applicable to non-exempt Goods & services, perhaps with an intermediate 2-3 rates.

Q 8. Specifically, what should be done to trigger genuine privatization of Central Public Sector Enterprises?

Answer 8: Sell all loss making CPSEs: There are two critical elements. Value of Land with & without land use restriction in lease/sale dead. The Legacy cost of excess, unproductive labor. Public acceptability depends on careful handling of these issues wherever present.

Q 9. What can the Government do to stimulate exports? Are there any specific suggestions on exchange rate management?

Answer 9: Ease of doing Business for Cross border trade has not improved significantly and must receive urgent attention.  The Coastal Export/Employment Zones (CEZs) and a few (6 say) large Special Export/Employment Zones in the non-Coastal States, must be provided with laws (incl labor), rules & procedures which are competitive with China/Vietnam.  Exim-policy, import tariffs and export duties on agricultural require integrated reform.  Specific duties on Textiles imports need to be converted to Ad valorem (%) to eliminate evasion & corruption, a Tariff Reform Committee should be appointed to propose a rational policy for tariffs.

   REER is important for exporters in a 3-year horizon. Relative GDP growth and relative productivity growth play an important role in this context. In the short to medium time horizon (<3 years), Volatility is more important for exporters & importers, and monetary policy (Relative real interest rates and Base Money growth), plays an important role in stabilization.

Q 10. What should be the role of Monetary Policy? Any specific suggestions on more efficient transmission of Repo Rate to Exchange Rate?

Answer 10: As long as inflation is firmly on 4% target, Repo rate should be (reduced to) 4% (real 0%).  Base money growth must be maintained at a rate necessary to create a long-term liquidity surplus, to aid transmission. Small saving rates must be linked to market rates in Govt securities.

     RBI should mandate a RBI supervised re-rating of NBFCs and help in removing Systemic risk(along with govt). Ratings should be made public to improve market transparency & market based resolution of remaining issues, after eliminating systemic risk.

Q 11. Should the inflation targeting band of 4% +/- 2% be reviewed? Should we co-define and target core inflation along with this band?

Answer 11: NO. Govt created regulatory uncertainty must be minimized. The risk of greater uncertainty far out-weigh any potential gains from this.

Q12. What other steps are required to boost a) Private Consumption, b) Investment?

Answer 12:  Rural-Urban economy plus [ii]

a) Comprehensive Agricultural Market Liberalization (+R&D, e-extension),

b) Basic Education (quality, outcomes) and Job Skills [Low(agriculture, industry), Middle(services), High (modern manufacturing & services)]. Reform apprenticeship act to promote job related training.

c) Labor simplification & flexibility, Portability of & competitiveness in, PSI, PF & social welfare systems.

d) Land market liberalization: land use flexibility, particularly in rural areas (e.g. Corporate agriculture in wasteland, conversion of agricultural land to industrial estates), Encourage land pooling for development.

e) Accelerate Digital India(connectivity) Personal Data ownership/protection law!

(e) Complete FDI liberalization process

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[i] The chairmen of Maruti reported on CNBC TV18 interview that costs may have increased by 10-13% on different types of cars.

[ii] See also, Virmani, Arvind, “Policy Reforms for Reversing Slowdown and Accelerating GDP growth,” https://egrowfoundation.org/research/policy-reforms-for-reversing-slowdown-and-accelerating-gdp-growth/