India: Getting the economy to turn around
The slowdown in the Indian economy is far steeper than what most observers had expected. The government has announced a set of measures for revival. It has also indicated that more are in the pipeline. For this to have become necessary within weeks of the presentation of the Budget is not normal.
The measures announced, including the immediate provision of ₹70,000 crore to public sector banks, should inject enough liquidity into the system to make credit readily available through banks and NBFCs and at lower interest rates. This was essential and overdue.
Ready availability of credit at reasonable real interest rates is a prerequisite for a turnaround. While this is a necessary condition for restoring the growth momentum in the economy, it is not a sufficient condition.
The real problem in the economy right now is the rapid decline in demand. The core challenge is of stimulating demand. As the finances of the government are under stress and the government is committed to containing the fiscal deficit, the conventional measures of stimulating demand through lowering of tax (GST) rates and increasing public expenditure significantly seem to be off the table.
Many of the reform measures that are being suggested may be necessary but would help growth only in the medium term. The recently announced decision of the merger of public sector banks is a good example. Benefits will accrue, not immediately, but over time. Increasing investment in infrastructure is a common prescription.
But from the date of an investment decision of a new infrastructure project, it takes a minimum of four to six quarters for bids to be invited, contracts to be awarded and for work to actually commence. Demand from starting new infrastructure projects would be created after over a year whereas the need is for creating demand right now. The challenge is to think of measures which will generate additional demand in the coming quarters.
There is a time-tested stimulus which has been part of the standard World Bank/IMF rescue packages. This is devaluation of the currency. The rupee had experienced real exchange rate appreciation of over 19 per cent from 2009 to 2017. This is the equivalent of lowering of import duties by 19 per cent over the same period. The consequences have been what should have been expected; stagnation in exports as well as of domestic manufacturing. Market forces have led to some depreciation of the rupee in recent weeks. However, market participants need a clear signal from the RBI that it believes in preventing the appreciation of the real exchange rate and would act accordingly.
It is only with the credible expectation of the real exchange rate being maintained that market participants would invest to increase capacity for exports as well as for the domestic market.
The past experience has been of episodic depreciation driven by market forces, followed by some years of steady appreciation of the real exchange rate.
A clear low-hanging fruit for stimulating demand immediately for domestic value addition and manufacturing is for the RBI to nudge the exchange rate gently downwards to undo the real exchange rate appreciation of the last decade. This is, however, unlikely to be considered till such time as the myth of a strong rupee being equal to a strong economy is dispelled.
This needs more informed discussion of the issue and better understanding of the success of the East Asian economies who kept depreciating their currencies to grow faster.
Driving the auto sector
The auto sector is the one experiencing the maximum difficulty. At the time of the 2008 financial crises, the purchase of buses for city bus services were grant financed as a part of the stimulus packages. A similar measure now would help the auto industry and improve public transport.
For old polluting trucks and buses, a scheme could be introduced where a cash rebate, which is well over the market price of the old vehicle, is given if a new vehicle is bought and the old one is traded in for being scrapped. There would then be an immediate surge in demand for these vehicles driven by the price signal of getting more than the prevailing market price.
There are a large number of private sector stalled power projects. Constrained supply of domestic coal, the higher price of imported coal, lack of demand and difficulties in restructuring debt as well as getting additional finance for time and cost overruns have all been contributory factors.
One radical way of removing the constraint of coal supply would be for Coal India to commit to meeting all present and future coal demand fully by importing sufficient coal to supplement its own production and to supply coal to all new users at a common pool price based on the heat content of the coal supplied.
Once coal supply in an equitable manner is assured, all stalled power projects become viable with varying degrees of hair cuts for the promoters and the lenders.
Power demand has begun to rise. With the completion of electrification of all households, the country will need much more electricity in the years to come. The government would need to direct Coal India to import coal and meet full demand as it would not take such a decision on its own.
With adequate coal at the same rate being assured, the government should be able to put in place financing for these projects. The demand for electricity would rise further by mandating the immediate closure of old inefficient thermal power plants. Such plants in and around cities could be asked to shut down to reduce air pollution. The Energy Conservation Act empowers the government to close down energy inefficient industries. Old inefficient thermal power stations can be closed down under this provision also.
Unconventional measures such as the ones suggested above for generating demand in the next few quarters could lead to the arresting of the slowdown. The revival of the full growth momentum thereafter may then be feasible.
Source: The Hindu Business Line