On August 21st, RBI published its annual report for the year 2019-20. It’s a voluminous document that runs over 300 pages. If you haven’t read it until now, here’s a summary in 5 sentences:
Governments don’t have magic wands.
Corporates don’t have many growth alternatives.
Falling demand has no fathom.
The optimism among investors has no boundaries.
And the common man has no hope.
As per the findings of RBI’s consumer confidence survey, the consumer confidence fell to an all-time low in July. A vast majority of respondents were pessimistic about the economic outlook, inflation and income scenario, and employment prospects.
Sure, markets might have already priced in this gloom but have they also discounted the deep-rooted problems that RBI has highlighted in its annual report?
RBI’s remarks on COVID-inflicted economic challenges, demand trends and India’s fiscal position require immediate attention.
Private consumption has lost its discretionary elements across the board; particularly transport services, hospitality, recreation and cultural activities. Behavioural restraints may prevent the normalization of demand for these activities.
Declining capacity utilization, the weakening of consumption demand and the overhang of stressed balance sheets are restraining new investment. The corporate tax cut of September 2019 has been utilised in debt servicing, build-up of cash balances and other current assets rather than restarting the capex cycle. These underlying developments suggest that the appetite for investment is anaemic and in need of more reforms.
In simple words, RBI has highlighted the real problem—lack of demand. When the government announced a stimulus package in May this year, economists and market experts were hoping to see the money being placed in the hands of the consumer, in some form. Since the government hasn’t ruled out the possibility of one more stimulus, if necessary, it might be open to such a step. However, the moot question is, does India’s fiscal position permit open-ended stimulus packages on the lines of those announced in the developed economies.
According to RBI, government spending has increased by 33.7% in Q1FY21 and it appears stretched at this juncture. This has severely constrained the options available to the government to spur demand. Can states take a lead on the reform agenda? RBI’s commentary on this subject too isn’t encouraging.
In the case of state finances, space is likely to be squeezed so much that cuts in growth-giving capital expenditure seem quite probable. The future path of fiscal policy is likely to be heavily conditioned by the large overhang of debt and contingent liabilities incurred during the pandemic. A credible consolidation plan, specifying actionable for reduction of debt and deficit levels, will earn confidence and acceptability, rather than just extending the path of touch-down.
The country’s Tax-to-GDP ratio touched an 11-year low in FY20, within which the Direct Tax-to-GDP ratio hit a 15-year low. Independent rating agencies have estimated a shortfall of as much as 30% in the central tax collections this fiscal. As a result, Tax-to-GDP may reach a new low in FY21.
The average Tax-to-GDP ratio in OECD group countries has been close to 34% whereas the global average is around 14%. Higher tax collections as a percentage of GDP enables governments to spend generously. Going purely by data, India doesn’t have that liberty at the moment. Not only is India’s per capita income paltry as compared to that of the developed world countries, it looks abysmally low even in comparison with that of major emerging market economies.
Looking at the table above, what do you think is the biggest hurdle in fostering demand—unemployment or stunted growth in the incomes of households? In the aftermath of the coronavirus pandemic, industry experts believe that the big businesses may get bigger and small business could get marginalized. Under such circumstances, household incomes may come under severe pressure. Half of India’s population still depends on agriculture for livelihood—a sector which is currently facing the problem of oversupply and inventory management. RBI’s remarks on this subject give rise to more questions than they answer, especially those pertaining to India’s miserable per capita income.
Experience shows that in periods when the terms of trade remained favourable to agriculture, annual average growth in agricultural gross value added (GVA) exceeded 3 per cent. Hitherto, the main instrument of incentive has been minimum support prices, but the experience has been that price incentives have been costly, inefficient and even distortive. India has now reached a stage in which surplus management has become a major challenge. The priority is to move to policy strategies that ensure a sustained increase in farmers’ income alongside reasonable food prices for consumers.
India’s Credit-to-GDP ratio is also one of the lowest amongst the major economies. Lower per capita income and lower Credit-to-GDP are interlinked factors.
Leading Indian banks have raised substantial capital during the pandemic times and have expressed the intent to use it for credit expansion in future. That said, they have become risk averse due to legacy of NPAs.
As part of the Atmanirbhar stimulus package, the government launched a credit guarantee scheme for MSMEs thereby urging banks to lend generously to MSMEs without fearing a potential bump up in the bad assets.
RBI has drawn attention to the real issue—productivity and legal framework.
The MSME sector has the potential to become the engine of growth, but it has been underperforming for too long owing to various structural reasons. This sector has been constrained by high cost of credit due to lack of adequate information, lack of modern technology, no research and innovations, insufficient training and skill development, and complex labour laws.
The trend of businesses relocating outside the China is real and may even amplify going forward. India has achieved some initial success in attracting foreign capital even during lockdowns, at good valuations; however, can this sustain?
There’s no dearth of flip-flops.
The case in point is one state cancelling the power purchasing agreements signed by its predecessors in office, citing which foreign investors pulled out from the state declining to make any further investments. The other extreme is a few states completely shunning labour laws to roll out the red carpet for companies looking to relocate outside China.
By being the home to 26.7 crore people, Indonesia is the world’s 4th most populous country and with its 12.9 crore population, Mexico ranks 10th. On the other hand, when measured on per capita GDP, the Indian economy stood 139th on the list of 186 countries, according to IMF, while Mexico and Indonesia ranked 64th and 116th respectively.
Attracting foreign businesses and encouraging domestic manufacturing could be a limited period offer for India since there’s a fierce competition among emerging economies to grab China’s share. Problems that India faces today have no quick fixes. Unless addressed in a timely manner, India’s favourable demographics could become a monkey on its back.
Indian policymakers have refrained from adopting an ultra-loose fiscal and monetary policy approach so far, and rightly so. But how long they can continue with the same resolute is a million-dollar question.
In the land of the Mahatma, politicians are turning a blind eye to realities, investors are turning a deaf ear to the voice of the economy and the common man is playing the role of a mute spectator.
A true jio ram bharose moment!
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