Green shoots in our economy: Are they real and sustainable?
After seven months of severe stress triggered by a severe lockdown, there is some good news on the Indian economy. A bountiful monsoon has brought cheer to farmers, with a record output expected in the kharif crop season. With reservoirs filled to the brim, output is expected to be bountiful in the rabi season as well. Increasing purchasing power in the hands of farmers is expected to increase rural demand. There has also been an appreciable improvement in the performance of both manufacturing and service sectors in October. The manufacturing purchasing managers’ index (PMI) at 58.9 in October marks the fastest output increase in 13 years. The services PMI has moved into the positive zone after eight consecutive months of contraction, touching 54.1 in October, compared to 49.8 the previous month. Core sector growth has shrunk by just about 0.8% in October on a year-on-year basis. Passenger vehicles sales saw a sharp increase during the month, with Maruti Suzuki recording 19% sales growth. The strong rebound in exports in September has created a current account surplus. Increased consumption of petroleum products since September and higher electricity generation indicate that the economy is recovering fast. Foreign direct investment from April to August this year was a record $35 billion, indicating the confidence of global investors in India. The continuous improvement in Reserve Bank of India’s (RBI) indices on consumption and business sentiment for next year too indicates that confidence levels are on the rise. Railway freight movement recorded an increase of 15%. Most importantly, goods and services tax (GST) collections, which represent the consumption of taxed goods and services, reached ₹1.05 trillion in October, an increase of 10% on a year-on-year basis, and was the highest in the last eight months. The last time GST collections had crossed ₹1 trillion was in February.
While the news of a recovery is comforting, it is premature to conclude that India’s economy has turned a corner. Of course, the immediate demand and supply disruptions caused by the world’s severest lockdown from end-March have severely curtailed economic activity, and will gradually return to normal as restrictions are relaxed. However, continued spread of the pandemic has constrained the relaxation of restrictions beyond containment zones. Activities in sectors such as travel, tourism and hospitality remains constrained, while others like construction and organized retail are struggling. Besides, as covid-19 vaccines may take time to administer, there is a crisis of confidence.
While the adverse economic consequences of the lockdown are transitory, there have also been structural factors behind the economic slowdown. It must be noted that the economy was already slowing for several quarters before the pandemic struck. India’s gross domestic product (GDP) growth decelerated from 8% in the first quarter of 2018-19 to 3.1% in the last quarter of 2019-20, and investment levels during this period declined from 30% of GDP to just about 26%. With a balance sheet crisis affecting corporates, banks as well as the government, there has been a sharp slowdown in investment activity. Companies were not willing to borrow and lenders unwilling to lend, while the government does not have the fiscal space to provide worthwhile stimulus. Thus, while a full resumption of economic activity might take us back to the 2019-20 levels of income, accelerating the economy’s growth trajectory requires addressing its structural problems.
Admittedly, the government has undertaken a number of reform measures in the farm sector and has sought to deliver labour market flexibility. The liquidity support, restructuring of loans and regulatory forbearance, along with rate cuts by RBI, have been helpful in enabling micro, small and medium enterprises to remain afloat. However, some immediate actions would help the recovery to gain speed. Besides a progressive relaxation of restrictions, the most important “stimulus” the government must impart without any further delay is to clear all pending bills of contractors. Even though there was some progress on this front at the Central government level, the problem continues at the state level, as states themselves are faced with severe revenue constraints. Besides clearing contractor bills, providing additional fiscal stimulus to increase aggregate demand would accelerate the recovery. While the absence of fiscal space and concern over the deficit are real, it is necessary to relax norms in exceptional times. The present situation requires a loosening of purse strings. But, for the comfort of rating agencies, it is important to provide a credible adjustment plan for the future.
An interesting development in October was the increase in GST collections. While pent-up demand and an economic recovery can provide partial explanations, the introduction of e-invoicing system for businesses with revenues above ₹500 crore could also have been a factor. Stabilizing this technology platform will go a long way in improving tax compliance, and timely monitoring of input-tax credit claims will improve compliance. This could trigger increased revenue productivity, which could offer an ideal time to undertake reforms in the structure of this tax. Perhaps reducing the tax rates on construction materials such as cement, steel, paints and plywood from the “sin” rate of 28% to a general rate would help revive the labour-intensive construction sector. That would also hold true for passenger vehicles. Further, besides a rationalization to avoid an inverted duty structure, this is an opportune time to evolve a three-rate structure—comprising a general rate, a merit rate and a “sin” rate, as was mentioned by finance secretary Ajay Bhushan Pandey in his recent interaction with the media. This would require the government to convince the states of such a shift in the GST Council.