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As Modi gets down to the brass stacks of forming the cabinet and setting the agenda for his second term, the economy he inherits is not in the best of shape.
The political uncertainty is now over, and the people of India have spoken loud and clear. Modi will return as the prime minister of the country for a new term with an even larger mandate. As Modi gets down to the brass stacks of forming the cabinet and setting the agenda for his second term, the economy he inherits is not in the best of shape. Overall growth momentum in the economy is slowing driven by consumption. Agriculture remains in stress due to ultralow inflation. The financial sector has not yet fully recovered from the NPA crisis and now new stress is emerging in the form of NBFCs. And government finances are not in the best of health.
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There is thus growing demand for urgent solutions to these and some other problems to ‘fix’ the economy. Implicit in the buoyancy in financial markets is that a solution is coming soon. And it certainly is tempting for any government to deliver on some of these expectations and keep up the good mood. And historically this is the path governments have preferred. Simply because the solutions are known and easy to implement. There are however serious problems in this approach.
The first is that these solutions do not really solve the problems, they just put a temporary band-aid and push the can down the road. Take banking for instance. That the banking sector is in a mess has been known from 2013-14 onwards but there hasn’t been any real solution to it. We have provided the banks with more capital for them to write off their loans but their governance structure and incentive structures haven’t really been fixed to ensure that these things do not repeat themselves again, at least not at this scale. The allure of pretending that bad loans are not bad is so high that we are continuing with this in the power sector. And this is not even about ownership of banks. Agriculture is a similar story where every few years when the crop cycle becomes unfavourable, policy makers respond with a debt waiver or higher support prices only for debt to accumulate again a few years down the line to be waived off again.
The second issue is philosophical. The perception that every downturn or stress point in the economy should be addressed, rather than left to the market to resolve for itself, is a relic of our socialist upbringing. If the real estate sector is struggling, it needs stimulus. If exports are struggling, they need a stimulus. If aviation companies have taken on too much debt and some of them are struggling, the sector needs a ‘package’ or ‘accommodation’ to ensure that planes keep on flying, if consumption is slowing, consumers need a stimulus. Every time the GDP growth slows down a percentage point or two, the economy needs a fiscal and/or monetary stimulus. These things are almost taken for granted in the popular discourse.
The implicit assumption being that any stress or slowdown is bad and needs to be arrested. For this presumes that the normal state for an economy to be is in an expansionary or stable growth. But, downturns in a business cycle or even any sector are incredibly important. They are a natural means for markets to rebalance – to signal excess or
under-capacity in a sector, to direct resources into or away from a sector, to blow off some steam from the economy. These are important signals an economy needs to auto-correct itself. If the excesses in the investment cycle were recognised in 2010 or 2011 itself, something the RBI’s policy of restructuring loans delayed, the NPA mess would not have been as big a problem as it is today.
So, the focus of policymakers ought to be on solving the longer-term structural issues that hold back an economy rather than optimise for short-term economic performance. Let the economy be as it is in the short-term. And there are several such policy interventions needed in our case. Things that stop or inhibit the business activity or trade or increase costs for the same – things that sap productivity. ‘Ease of Doing Business’ is a powerful policy initiative that Modi had in his first stint as the prime minister. Short-term interventions, fixes, packages, bailouts are only to be deployed when the costs of inaction cross certain unacceptable thresholds – like they did during the global financial crisis for several developed economies.
So why do policymakers opt for short-term patchwork policies instead of structural reforms? They do so because it is easy to implement these things. The solutions are in a sense already known (it’s the same thing they did the last time there was a problem). But also, because governments always have an eye out on winning the next election and they do not want to offend any of the entrenched lobbies (vote banks) which resist change. These lobbies tend to be very organised and vocal also. They are also unwilling to take the short-term costs that come with structural reforms. So, the status quo and incrementalism (tinkering) on one hand and handouts on the other, in a sense suits everyone.
But Modi has no such compulsions. The nature of his persona, the immense political capital that he commands, and the size of his mandate means that he is under no compulsion to manage the economy with the time horizon of a few quarters. That he won despite the economy not being in the best of shape means that he has no short-term compulsions that force sub-optimal policy choices. Unlike governments in the past, he can manage for the long-term. He is uniquely positioned to think long-term. He can move policymaking away from bailouts and stimulus and packages to removing distortions and failed interventions.
There a whole range of reforms from taxation to labour laws to agriculture that have been widely discussed and are well known that the government can implement. There is no point in going over them again. Suffice to say that the current government has little excuse, other than a lack of belief in those measures themselves, to not implement them. The current government has no political compulsions, as of now at least, to not implement reforms. And if in the next five years, we do not see at least some structural reforms, then it effectively means that there is no appetite for hard reforms, ones that impose short-term costs on the economy, with anyone. We might as well forget them for a long, long time. A good start for the government would be to lay down a framework for how it thinks about the economy which can set expectations. A framework that covers everything from the role of the state in business to its view on the fiscal deficit to privatisation to regulation and trade. For example, if the government does not believe in a 3 percent fiscal deficit target, it is better to state it upfront rather than have questionable disinvestments or rolling over of expenditure or off-balance sheet structures. Or if the government does not believe in privatisation, it is better for it to state it upfront so that expectations are set accordingly. Similarly, with tariffs, if the government believes in tariffs as a policy tool, it is better to be clear about it. This will help analysts and investors better anticipate government policy and be prepared for it.
Ashutosh Datar is a Mumbai-based independent economist.