Government must take steps to break the spiral of lack of trust. It has the instruments and the authority to verify. The public does not have the tools – beyond the democratic elections to hold the government accountable for its promises.
India’s Central Statistical Organi- sation (CSO) placed the country’s nominal GDP at Rs 152.54 lakh crore (or, Rs 152.54 trillion) for the year ended March 2017. In the same year, the average rate for the dollar was Rs 67.05. That translates into a nominal GDP of $2.28 trillion. If we assume that over the next thirteen years, India’s nominal GDP in rupee terms will grow at 10 per cent per annum, then the Indian economy will be Rs 527 trillion big. If we assume an average exchange rate of Rs 60 to a dollar, then the Indian GDP will be around $8.8 trillion. Many assumptions are behind this estimate. Are they realistic or are they conservative?
We have assumed a nominal GDP growth rate of 10 per cent. The nominal growth has two components: a real part and an inflation part. I considered an inflation rate of four per cent, which means the ‘real rate’ is about six per cent per annum. This assumption is conservative considering that between 1979 and 2009, according to the World Bank, China’s real GDP growth averaged 10 per cent.
THE THREE Ds AND THE INDIAN ECONOMY
Ruchir Sharma noted that the global economy is in the grip of three Ds – de-population, de-leveraging and de-globalisation. Countries need to be clear-headed about the factors that they can control or influence and the factors they cannot. They need to work on the former and wait for the right opportunities on the latter. Where does India stand concerning the three Ds? The answer to this question will decide India’s size potential in 2030.
The developed world’s population and labour force growth is slowing. India’s population growth rate too has slowed. At 1.2 per cent in 2016, it is lower by 0.1 per cent than the global population growth rate.
De-leveraging is not India’s problem yet. Indian public debt (Union and state governments combined) is high at 69.5 per cent of GDP. India’s private non-financial sector (includes companies, unincorporated businesses and households excluding banks and other non-banking financial entities) debt/GDP ratio was 36.0 per cent in 2002 and peaked at 68.6 per cent in 2014. But, since then, de-leveraging has been underway. The rate has come down to 55.9 per cent. India’s households have very low levels of debt by global standards. Hence, despite the government’s high debt ratio, India’s overall debt ratio at 124 per cent of GDP is on the lower side. Debt can be harnessed to boost growth.
However, India’s financial sector, dominated as it is by the government, is not in a position to lend. Until banks remain under the control of the government, the government’s budget constraint will be binding on banks’ ability to raise money. Without adequate equity capital, they cannot expand lending. The current crisis could have been an opportunity to pass the banking system on to private hands, but that opportunity has been allowed to slip. Disasters are the best times to whittle down political resistance to fundamental changes. Perhaps, in the unique Indian style, we might get to a banking system that is not dominated by government shareholding by stealth and in our opaque manner!
De-globalisation is a very significant threat. India routinely sets export targets for the economy. Frankly, that is a futile exercise. Exports are determined by global demand and by the competitiveness of the goods. While the latter is in our control, the former is not. Hence, the government must set targets for improving the quality, indispensability and competitiveness of Indian exports and then hope that global buyers take notice. Unfortunately, one does not see such marks. India’s export performance has been disappointing in recent years. During the worldwide boom era of 2003-08, India’s exports rose briskly. Since then, they have stagnated.
A large part of the problem is in changing attitudes to foreign trade and imports along with changing attitudes to immigration.
Nations are becoming more protectionist and protective of their economies. We must appreciate this factor.
CULTURE OF EXPORT RELIANCE MISSING
Right after the Prime Minister’s speech at Davos, the Indian government increased import duties on several items. America has imposed stiff tariffs on washing machines and steel items. Both America and the European Union refused to grant China ‘market economy’ status at the WTO. Donald Trump walked out of the Trans-Pacific Partnership–a trade and investment agreement among nations soon after he took office in January 2017. There are rumours that he would pull America out of the North American Free Trade Agreement (NAFTA) as well.
East Asian countries, led first by Japan and now followed by China, had improved their economies and reached middle-income status mainly due to strong export market performance. Emphasis on exports raises the bar on domestic manufacturers regarding scale and productivity. Exports can quickly add a percentage point or two to economic growth, making up for local slack. India is likely to miss out on that for several years. That’s because we are not used to sustaining high export growth. The culture of export reliance is missing. It takes years to form that habit.
TRADE WAR A DISTINCT POSSIBILITY
Srinivas Thiruvadanthai, Chief Economist at the Levy Forecasting Institute in New York, laid out the challenge that India faces: “India needs to brace itself not just for a flood of cheap imports from China but also a potential reversal in the long trend of globalization. Trump’s message on economic nationalism, hitherto banished from polite conversation, is likely to experience revivalism across the world in the years ahead. As global trade shrinks, the positive-sum aspects of it will dwindle, making it harder to paper over the negative aspects of trade. A trade war is a distinct possibility.”
In other words, boosting economic growth and export growth is as much a productivity challenge as it is going to be a political challenge. Is India’s statecraft up to it? We will examine the productivity challenge.
INTERNAL GROWTH BARRIERS. THE PRODUCTIVITY CHALLENGE
In January 2018, credit-rating agency Fitch placed India’s real growth potential at 6.7 per cent. Fitch analysts noted two big concerns. One is that India’s labour force participation rate is low. Far too few women are in the labour force and there is a problem with skill endowments of youngsters that prevent them from being absorbed into labour force. The second concern is India’s abysmal Total Factor Productivity (TFP) Growth.
TFP is the extent of economic growth (or, output growth) that is not explained by input-growth. TFP growth is the output growth rate that is over and above the ‘inputs’ growth rate. India’s TFP growth rate was 0.6 per cent in the last several years. Fitch notes, “sluggish TFP growth in a low income per capita country such as India is all the more disappointing.”
Disappointing export and productivity performances signal the formidable underlying challenges that India faces. The factors that have led to this sluggish TFP growth are many. Not only labour laws and hiring practices, but also inadequate education, plus an inadequate skilling hold back labour productivity. Corporate governance, as much as government approvals and clearances, mar capital productivity.
THE PSYCHOLOGICAL CHALLENGE
India has come a long way since the 1990s. GDP rate, per capita income, literacy, and life expectancy have improved. Infant mortality rates and poverty rates have declined. These have been accomplished without taking recourse to too much of debt (unlike China) and within a noisy, often dysfunctional, democratic political setup. That is the ‘good’ part. The not-so-good part is the fact that GDP growth rates and per capita income growth rates have slowed in recent years. Savings and investment rates have declined.
Some of this slowdown is due to global factors and slowing population growth.
Governments must focus on spheres of control and work on improving outcomes within those spheres. Control instincts usually triumph over the inclination to let go. There is an atmosphere of distrust and mistrust between the governing and the governed. Governments have not delivered to the degree promised on health, education and infrastructure. That is a breach of contract.
EDUCATION CESS – BACKDOOR TAXATION
The Comptroller and Auditor General of India, in his report on the finances of the Union government (Report No. 44 of 2016-17), noted that over the last ten years, the Indian government had collected around Rs. 840 billion of education cess. But this amount has not been earmarked in the Public Accounts of India nor has any appropriate scheme notified to make use of the amount collected for education. Mostly, it is backdoor taxation. To neutralize the noise, the government exempts the vocal classes from specific taxes or raises the tax threshold. The tax base shrinks. Others feel persuaded to evade. It is a downward spiral.
TRUST – DEFICIT
The government must take steps to break this spiral of lack of trust. It has the instruments and the authority to verify. So, it can trust. The public does not have the tools – beyond the democratic elections – to hold the government accountable for its promises. Hence, it is upon the government to trust and let go. It is the control mindset blended with a moralistic attitude towards economic activity that obstructs creation of capacity and scale in the private sector. Her ‘anti-big’ bias is one reason for the drift. The re-introduction of the Long-Term Capital Gains tax is a case of moralising. The short point is that limits on India’s growth placed by low productivity could be a manifestation of psychological limitations. The more the Indian policymakers are freed from their inherited mental shackles, the more the Indian economy will be able to break free of its growth shackles.
If that happens, a $ 9.0 trillion economy by 2030 will be a floor and not a ceiling for India.