Montek Singh Ahluwalia | Sanjay Ahlawat
Though the Indian economy is in recovery mode, the underlying growth impulses are weak, says economist Montek Singh Ahluwalia. The former deputy chairman of the Planning Commission says the situation calls for specific corrective action.
In an exclusive interaction with THE WEEK, Ahluwalia talked about a range of issues—from fiscal deficit to tax reforms and employment. Excerpts:
Q/What is the current state of the economy? Will the third wave of the pandemic affect recovery?
A/There is no doubt that the economy is recovering from the shock of the pandemic in 2020-21. The whole world is. The question to ask is, are we doing better than others?
The National Statistical Office has projected 9.2 per cent growth this year, based on data for the first two quarters. Signs of recovery weakened in the third quarter and independent analysts are projecting lower growth of 8.5 per cent. This will still leave us the fastest-growing major economy this year, but that is only because we had the largest contraction last year. Other economies have recovered sufficiently to raise their GDP to a level higher than the pre-pandemic year of 2019-20. In our case, we will just about get back to the 2019-20 level.
A basic problem with the recovery is that it is not even. Several sectors have performed well, but the services sector (hotels, airlines, restaurants, etc) is badly hit. The third wave will postpone the recovery in these sectors further. It is called a ‘K-shaped’ recovery because those in the upper-income groups have done well but those lower down, especially those in the informal sector, have been badly hurt. Jobs have been lost and poverty has increased.
Other economies have recovered sufficiently to raise their GDP to a level higher than the pre-pandemic year. In our case, we will just about get back to the 2019-20 level.
Q/What should be the finance minister’s priorities in the budget?
A/It depends on how she diagnoses the underlying problem. If she believes the economy is recovering strongly, then perhaps she might focus all her attention on making sure that the macroeconomic situation--basically the fiscal deficit--remains under control and there is progress on the reforms front. However, if she believes the underlying growth momentum is weak, she needs to address the specific reasons for that weakness.
I think the underlying growth impulses are weak and call for specific corrective action. The National Sample Survey Office projected growth in the first two quarters as averaging 13.7 per cent, but for the year as a whole, it has projected 9.2 per cent. This can only mean that the average growth in the third and fourth quarters will be around 4.9 per cent. In other words, the underlying growth momentum as we enter the next year will be about 5 per cent or so.
The IMF has said India could grow much faster next year and that is based on the judgment that India has the potential for higher growth—provided some of the policy support needed is forthcoming. I agree with this assessment but to make it happen we have to take the critical steps that will have an impact in a relatively short time.
The demand side does present problems. Private consumption is weak and the consumption of the poorest segment has been adversely affected by the K-shaped recovery. A sustainable revival in consumer demand in this segment depends upon a recovery in employment. This will come if growth can be accelerated. The problems of micro, small and medium enterprises need special attention. There is a case for programmes that support income for the poor. The MGNREGA scheme for example, where states have said they are not getting enough funds should be fully funded.
Q/What is your view on the fiscal deficit and what should it be next year?
A/The fiscal deficit target of 6.8 per cent for the current year is likely to be achieved. Tax revenues have done better than [what was] targeted, but this is offset by shortfalls in privatisation revenues. Quite a lot of the expenditure takes place in the last quarter. I hope that the finance ministry does not try to contain it in order to show that the fiscal deficit is on track. They should provide fully for the National Rural Employment Guarantee Scheme. They should also provide fully for procuring vaccines for the current year and also in anticipation for the next year.
For the coming fiscal year, I assume the finance minister will want to show a modest improvement, reducing the fiscal deficit for 2022-23 to say 6.3 per cent. That is still high, but given the weak growth impulses at present, and the likelihood that monetary policy may have to be tightened because of inflation fears, a sharper fiscal correction is not warranted.
The important thing on the fiscal side is to implement a credible medium-term plan of bringing the deficit down in the future. Here again, achieving higher growth is the best way of reducing the fiscal deficit as a percentage of GDP. So, we should look at what policy initiatives can be pushed in that context.
While on the subject of fiscal deficits let me add that the macroeconomic health of the country is usually judged by the combined deficit of the centre and the states. This presents a worrying picture. The states complain that they have not received the compensation for the shortfall in GST (Goods and Services Tax) revenues that they were promised when they agreed to the GST. They are being allowed to borrow more, but that borrowing adds to the fiscal deficit. They are also being allowed to borrow more to finance power sector reform. These additional borrowings add up to a worrying picture.
Q/Should tax reforms be high on the agenda?
A/Taxes are a core budget issue. I am sure the minister has received many requests for lowering rates on income and corporate tax. I hope she ignores these requests. Corporate taxes were lowered recently and they are now at very competitive levels. As for personal taxation, the rates are quite modest.
The area where tax reform is desperately needed is the Goods and Services Tax. This is widely regarded as a pathbreaking reform that was meant to generate greater revenue buoyancy. GST revenues have done well in the current year, but that is only a recovery from the depressed levels last year. GST revenues as a per cent of the GDP are the same as they were before the pandemic.
We need to bring about some basic changes in the structure of GST rates if we are to reap the full revenue benefits. The list of exempted goods is too large and it should be sharply pruned. Second, instead of the present four rates (5, 8, 18 and 28 per cent) we should cut the number down to two, say 10 and 15 per cent, plus a ‘sin tax’ on selected luxury goods. We should also bring real estate, petroleum, alcohol, and electricity into the GST.
Changes in the GST cannot be legislated by Parliament. It has to be done by the GST Council. But it would be good for the finance minister to say in Parliament what she wants the reform to be and indicate that she will try and push it through the GST Council later in the year. Support for these changes in Parliament would help push them through the GST Council.
I also wish she signals the start of a process of reversing the increase in customs duties that was started three years ago. Our customs duty rates are too high and they reduce the cost competitiveness of industry. These high rates prevent us from integrating with value chains in East Asia at a time when geopolitical developments around the world have created a desire to reduce the high dependence of these value chains on China. We should use this opportunity to integrate more closely with supply chains in Asia. If we want to help particular industries for a period, let us do so through the PLI scheme, but not through higher customs duties.
Q/What are the other reforms we need to ensure a higher growth rate?
A/There are many, but let me just mention two. Since private investment will take time to rebound, we should aim at expanded public investment in infrastructure. India has a huge deficit in infrastructure. Closing this gap will be the best way of stimulating a strong revival of private investment. The national infrastructure pipeline is an attractive slogan. Implementing it on the ground, based on some clearly identified projects with a defined timeline, would have huge payoff.
Second, I would emphasise the need for pushing reforms in banking. This is in the domain of the finance ministry itself, but action has been very slow. I do not know the latest position on the proposal to privatise two public-sector banks, but if a timeline can be announced, it would help.
Apart from privatisation of individual banks we should consider ways of removing the restrictive control the finance ministry exercises on public sector banks, which is not consistent with these banks becoming efficient and competitive with private sector banks. Unlike privatisation, this would not evoke any resistance from the unions and substantive progress in this area would be a big plus.
The Insolvency and Bankruptcy Code was another important reform which has not had the impact it was expected to have. It was then effectively put in cold storage because of the pandemic and the perception that recovery efforts had to be put on the back burner. As the situation begins to normalise, especially for the formal sector, it needs to be put back on the front burner, with banks encouraged to use it to deal with problem accounts.
Bringing the banking system back to good health is essential if the economy is to grow more rapidly. It is also essential for ensuring that MSMEs get access to credit as they start the process of rebuilding in the post-pandemic world.