From UPSC perspective, the following things are important :
Prelims level : Nothing much
Mains level : Structural slowdown; Regulatory supervision
India is in the middle of a sharp growth slowdown. The debate surrounding the slowdown is whether it is a cyclical downturn or a structural correction. Diagnosing the problem is key for devising policy responses.
- Cyclical slowdowns can be dealt with using temporary fiscal and monetary stimulus.
- Structural problems require long-run policy responses.
The slowdown is structural – Oil imports
- Most of the growth between 2014 and 2017 was sparked by a sharp increase in government spending.
- Given India’s oil imports, the decline in the world price of oil by almost $50 a barrel between 2014 and 2016 represented a windfall revenue gain of 3% of GDP.
- Since the fiscal deficit barely moved, the government effectively used the windfall to finance various government schemes.
- Now that oil prices have reverted towards their previous levels, a stable fiscal deficit demanded a reduction in government expenditures.
- If there is no oil windfall, Indian growth over this period would have been 2-3% lower annually. The economic slowdown has been ongoing for almost four years now.
- Cyclical downturns last a few quarters, maybe a year. Negative growth pressures for four years indicate structural problems.
Structural slowdown – investment demand
- Throughout the period 2016-2018, there was a criticism of the Monetary Policy Committee’s refusal to cut rates.
- It was argued that high real interest rates, along with the restrictions by RBI on banks’ lending to deal with the NPA problem, were jointly responsible for low investment demand.
- Since the beginning of 2019, both the monetary policy stance, as well as PCA norms, have been relaxed by the RBI.
- However, investment demand has barely moved in response.
Dealing with structural slowdown –
- Dealing with structural problems doesn’t require fiscal spending. It involves non-pecuniary costs.
- The government has to expend some of its considerable political capital in order to usher in long-term labor and land reforms.
- For these, the state governments have to be roped in to get these reforms going.
Corporate tax reduction
- The move to lower the corporate tax rate is a good one. It is like a capital market structural reform as long as it is not used as a temporary fiscal measure.
- The government needs to signal unambiguously to markets that this is a permanent reduction of the base rate.
- The public sector banking network accounts for 75% of India’s banking assets.
- Public sector banks introduce two complications to the financial system.
- They allow for the capture of the credit allocation system by non-market forces.
- Regulatory capture – Since the regulator of banks is the RBI which is itself owned by the government, this amounts to the regulator regulating the entity that it itself is reporting to.
- The government can induce regulatory changes by just changing the personnel it appoints to the upper management of the RBI or to its board.
- India needs to urgently begin reducing the importance of public sector banks in the economy.
- This can be done either through privatisation of existing public sector banks or through the granting of banking licenses to private operators.
- On-tap banking licenses have attracted little interest so far suggests that the privatisation of public sector banks needs to be prioritised.
- The idea needs to be pursued for multiple reasons.
- Sovereign bonds would force government debt to be priced in a more competitive setting. Currently, it is priced in a sheltered domestic bond market.
- Issuing sovereign bonds will force greater clarity and transparency of macroeconomic data since international creditors will demand that.
- Things like failure to achieve policy targets or reticence in releasing data will attract rapid punishment by markets. This will provide greater discipline for policymaking.
- The government should revisit the appointments process to key technical and regulatory bodies.
- Functions like monetary policy, banking supervision, data collection and dissemination, the audit of government financial accounts need to be independent of government direction.