Economic growth: Why an ill-thought crusade against NPAs could push the economy further downward – The Economic Times–01.10.2017

By KM Chandrasekhar

 

The state of the Indian economy has been the flavour of the week. There has been informed discussion, acrimony, pathos, sarcasm, the works — and, that too, coming from significant political dignitaries, past and present, economists of all hues and people who know everything and hold strong and unshakeable views.

The economy is a dynamic process, ever changing. Rigid views and opinions do not sit well in dynamic situations. It was reassuring to hear from the Finance Minister that government would be proactive, that it would analyse the situation and take remedial action where necessary.

This implies a readiness to change track and move quickly. Whether in the economic field or any other sphere of human endeavour, there will always be triumphs and failures, mistakes and corrections.

Need for Change
That the economic situation deserves attention is a fact beyond dispute. The growth rate has declined to 5.7% in the first quarter of 2017-18. There is prevailing concern over rates of growth in the job market. Exports have been falling as the sluggish global economy struggles to find its feet again.

Credit offtake fell to 3.3% in February this year. Above all, rates of investment and rates of domestic saving have dropped sharply. The stock markets are beginning to show signs of fatigue. There is singular lack of interest in IPOs. Clearly, this is no time for business as usual and a realisation that change is necessary is the first step forward.

Hopefully, that first step is now behind us. The global situation shows signs of some improvement. The World Bank puts global growth this year at 2.7% against 2.3% in 2016. The IMF gives figures of 3.1% in 2016, 3.5% in 2017 and an expected 3.6% in 2018. The World Trade Organization forecasts an improvement in global trade from 1.3% in 2016 to a range of 1.8% to 3.6% in 2017 and 2.1% to 4% in 2018.

All these figures show a rising trend and it would depend on the wisdom and sagacity of policy makers to make full use of the emerging global opportunities.

The answers to the problem are many and, no doubt, the newly appointed economic advisory council is working on them. The most significant element in any package of solutions should be raising the level of investment, whether it is public or private. A gross fixed capital formation to GDP ratio of about 27%, down from a level of 34% in 2013-14 is obviously not good enough.

Why an ill-thought crusade against NPAs could push the economy further downward

I read an article recently by Sashi Sivaramkrishna of Narsee Monjee Institute which brought out some interesting facts. He talked of a 2013 working paper of Bose and Bhanumurthy of National Institute of Public Finance and Policy (NIPFP), which estimated the capital expenditure multiplier as 2.45. That is, if government spends a rupee on capital expenditure, GDP will rise by Rs 2.45. Thus, assuming these rates, an expenditure of Rs 40,000 crore will lead to additional GDP growth of 0.75%.

Likewise, studies done by the International Labour Organisation in Gujarat and West Bengal on employment multipliers in road construction show that a 2% increase in GDP could potentially create 6 crore more jobs. Of course, some part of the multiplier effect would be absorbed by supply side constraints, which could result in inflation in areas where such constraints exist but, in an economy generally characterised by relatively high unutilised capacities, the inflationary effect would be minimal.

And, really, what option do we have when private investment rates are so low? Whenever we talk of increased public investment, we confront an impassable barrier erected by many who believe in the sanctity of keeping the fiscal deficit at an arbitrary level of 3% or so. The fact is that the fiscal deficit ratio consists of a numerator, the fiscal deficit in absolute terms and a denominator, the GDP. Higher investment would raise the numerator, but the higher investment would itself raise the denominator through the multiplier effect. Thus the fiscal deficit, in due course of time, would correct itself.

The 2008-09 stimulus, which led to quick economic recovery, was blamed for inflation which came some years later, but this was perhaps more of a political reaction, which deliberately turned a blind eye to a host of other factors inducing inflationary pressures.

The GST Quotient
To raise private investment, production and utilisation of capacity have to be pushed up by profit considerations. This would involve raising effective demand through the purchasing power route.

The GST effect has to be carefully monitored and the basic price-reducing effects of input credits would need to be passed on to the consumer. This is at present constrained in practice by lack of full knowledge of how GST works, delays in grant of input credits, shortfalls yet to be set right in the GST network. Perhaps it will even out in time and market forces will prevail, but it is difficult to hazard a guess on how long it will take.

Meanwhile, there is pervasive fear in the lowest rungs of the supply chain of excessive regulatory action and the return in full force of the dreaded tax inspector. This fear is exacerbated by the fear of linkage with the income tax network which would pose a new set of problems, particularly if retrospective assessment provisions are used.

Unless carefully managed, the negative effects of GST can outweigh the positives a couple of years down the line. The effect on prices of high overall taxes on non-GST products, especially petroleum products, has to be studied and readjustments made. Identification of job creating, quick yielding areas for targeted intervention would also yield dividends.

Interest rates at this point may not be a significant factor in creating a climate for investment. But too much obsession with NPAs and regulation may be counterproductive.

NPAs can arise through bad banking practices. They can also be the result of economic slowdown. Unless a distinction is made between the two, the crusade against NPAs could push the economy further down. Mature fiscal and financial management and stability should be the watchwords.

The writer is a former cabinet secretary

via Economic growth: Why an ill-thought crusade against NPAs could push the economy further downward – The Economic Times

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