That the Indian economy is witnessing a slowdown is no longer a matter of debate after the Union finance minister acknowledged this reality. The days when the Indian economy was the fastest growing seemed distant when the second quarter of 2019-20 saw the growth stumble to 4.5%, the slowest in 26 quarters.
The three drivers of growth, namely, consumption, investment, and exports, have all moved downward. Consumption was reported to be at a four-decade low, with rural consumption lower by 8.8%, while urban consumption barely increased. In the second quarter of the current fiscal, gross fixed capital formation (at constant prices) grew by a mere 1% over the corresponding period of 2018-19, while exports recorded negative growth.
These numbers, in our view, reflect the combined impact of four factors, namely, policy shocks, agrarian crisis, steep increase in unemployment and steady decline in the share of wages and financial sector crisis.
Except for the first, the remaining three are structural impediments that have plagued the economy in the past decades.
Two policy shocks, namely, demonetisation and introduction of GST, were imparted in rapid succession. The micro, small and medium enterprises (MSME) were especially impacted by demonetisation having lost 1.5 million jobs, according to estimates provided by the Centre for Monitoring the Indian Economy. The woes of the MSME sector were exacerbated by a poorly designed GST, which added a significant layer of uncertainty for the small businesses. The jobs and income losses resulting from the policy shocks caused demand shrinkage and sharp decline of investment.
India’s development model is skewed against the interests of the farm sector; the steadily falling share of the sector in the country’s GDP even when it supports an overwhelmingly large section of the working population. In 2005, the National Farmers’ Commission (NFC) emphasised the need for amelioration of the condition of the farming community, especially by increasing minimum support price (MSP) and by extending it for other major crops.
After an initial interest shown by the UPA government to meaningfully increase MSP, this recommendation of the NFC has remained unimplemented. Consequently, the terms of trade between farmers and non-farmers, which had increased up to 2010-11, declined thereafter. At the same time, wages received by farm labour also became less remunerative: they grew by an annual average of nearly 17% between 2007-08 and 2013-14, but in the past three years, their growth was halved. These two developments squeezed rural demand.
The Periodic Labour Force Survey of 2017-18 reported massive decline in agricultural employment and very slow growth of non-agricultural jobs. The unemployment rate stood at 6.1%, of which unemployment rate among the urban male youth was nearly 19% while the unemployment rate for urban female youth was 27% per cent. These figures were the highest in 45 years. Worse still, the total employment witnessed a net decline to 471.3 million in 2017–18 from 472.5 million in 2012—the first ever absolute decline in the post-independence period.
As for the urban sector, KLMES database produced by the RBI, shows that employment growth in manufacturing dropped to 1.4% and in services to 2% between 2011 and 2017 from 2.5% and 2.8 % respectively between 2004 and 2010. During the same period, labour earnings in the manufacturing sector declined from 8.1 % to 5.4% and in the services sector, from 7.2% to 6.1%.
Thus, falling rural income and urban labour earnings as well as skewed income distribution have resulted in domestic demand contraction while falling export growth has affected external demand.
Despite continuous capitalisation of the banking sector in the past several years (Rs 1.06 lakh crore in 2018–19 followed by Rs 70,000 crores in 2019–20), non-performing assets continued to grow. It stood at Rs 8.06 lakh crore on March 31, 2019. Even the non-banking financial sector is passing through a crisis. For example, Infrastructure Leasing & Financial Services has reported a negative net worth of Rs 16,935 crore in FY 19. These obviously adversely affected commercial credit off-takes. Financial sector crisis, together with demand slackness and investor pessimism have negatively impacted investment.
The government has taken several initiatives, including cut in corporation tax and announcement of packages for reviving sectors like the real estate, automobiles and exports. Ironically, all these are essentially supply-side measures, which would make no impact on a demand-constrained economy.
What should the government have done instead? Putting purchasing power in the pockets of those having high marginal propensity to consume should have received the topmost priority. This can easily be done through increased spending on schemes like MGNREGA, and by investing in education, health services and rural infrastructure. Such spending can immediately spur demand, which in turn would create inducement for potential investors.
In an exercise evaluating the impact of MGNREGA and two other social security schemes using the Social Accounting framework, we found that the indirect impact of expenditure on such schemes is considerable. Direct expenditure on a scheme like MGNREGA induces 1.8 times increase in indirect income and twice the direct expenditure in pension or basic income type scheme.
The government can garner enough resources for financing the above-mentioned initiatives by realising the undisputed part of tax and non-tax arrears, which, at the end of 2017-18, were around Rs 9 lakh crore and Rs 2 lakh crores respectively. It could also monetise the huge chunk of surplus land available with the Ministries of Defence and Railways, which was one of the recommendations of the Thirteenth Finance Commission.
Over the medium-term, efforts must be made to increase the tax-GDP ratio, which is the lowest among major economies, by levying wealth tax, among others. Besides, the GST must be reviewed and redesigned through reduction in the number of tax rates and increasing the base, and by improving the GST Network that the indirect tax system needs in order to be effective. All these measures would boost demand which in turn induce investment and reverse the downward trajectory of economic growth.
Atul Sarma is visiting professor, ISID, and former professor of Economics, Indian Statistical Institute. Biswajit Dhar is Professor of Economics in the Jawaharlal Nehru University.