Proximate causes for the slowdown are on the demand side. For several quarters now, growth in private consumption, the biggest component of GDP, has been sluggish. Private investment, the most important driver of GDP, hasn’t taken off. Exports have done reasonably well, but are unlikely to be a major engine given the global context of slowdown and trade aversion in the advanced economies. Essentially, the economy was being driven by public investment, which has been pared back a little in the interest of fiscal consolidation. Was that a mistake? No.
The public investment-led strategy has been in place for a few years now. It became the prime driver of growth when the banking and corporate sectors were under stress after a period of excess in the late 2000s-early 2010s. Banks needed time to reduce NPAs. Corporate balance sheets had to be deleveraged. That process is complete. The ‘shock’ effects of Covid and outbreak of the Russia-Ukraine war have also abated.
Ultimately, public investment should crowd in private investment. For that, government spending/borrowing must come down to free resources at an affordable rate to the private sector. In any case, given that India is a market economy, it can’t depend on the government fuelling growth for any great length of time.
Why is the private sector not responding? One explanation lies in the interest rate. Monetary policy is too tight. Cost of capital is high for individuals and firms. By keeping the repo rate unchanged, RBI is signalling concern about inflation, which continues to be at the upper end of its target range at 6%.
The inflation-targeting framework requires RBI to maintain the inflation rate within a target range of 2-6%. Keeping policy tight is the right thing to do if inflationary pressures are on account of excess demand. But it has been evident for several quarters that demand, represented by private consumption and private investment, is sluggish. The economy is not overheated. Inflation is on account of supply-side factors in fuel and food. Interest rates are too blunt an instrument to tackle that.The other boost to the economy can come from ‘structural reforms’ on the supply side, which can improve competitiveness and give private investment and exports a big boost. There is a long list of items: easier and cheaper land acquisition, flexible labour laws, affordable power, lower rail freight rates, faster clearances and farm laws reform (to address food inflation). But the political economy resists big-ticket reforms. GoI has tried to push some of these reforms, but has been forced to go slow or abort.What may be required is a division of duties between the Centre and states. For supply-side reforms, the onus should be on states. Many of the so-called ‘structural reform’ issues, including agriculture, are either state subjects or concurrent subjects so states are empowered. Politically, it may be easier to sell reform at a state level than across all of India. At least a few states may be able to carry out reforms, and put competitive pressure on other states to follow suit.
GoI should focus on the demand side. It should devolve all structural reform issues to the states. It needs to ensure that fiscal and monetary policy are in tune to supporting growth, while not abandoning prudence. The inflation-targeting framework may need a review. GoI can also work to manage foreign trade to the advantage of domestic players, particularly manufacturers.
New markets need to be opened through strategic free trade agreements (FTAs). Excessive imports from countries that are dumping products, subsidised or otherwise, into India below cost need to be contained, so that domestic demand boosts domestic supply rather than an influx of imports.
A concerted, constructive effort by GoI and states can put India onto a 7-8% growth trajectory in a relatively quick time.
The writer is chief economist, Vedanta.
