Economy Back from the Brink

In two years, the Modi government ended the policy drift, charted a bold new path for India’s development and set about translating its big ideas to reality. Strong political leadership has enabled the economy to bounce back, but much rides
on the future pace of liberalisation and upgrades
in governance. Team Inclusion takes stock of key economic developments in the two years of Modi government.

01 July, 2016 Economy, Article
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Two important shifts in economic management have occurred in the last two years. Prime Minister Modi has cleansed the power corridors of corruption and distanced himself from industrialists, lobbyists and crony capitalists.

The last few years of the United Progressive Alliance (UPA) government’s 10-year rule had left the Indian economy rattled. Corruption scandals ignited political firestorms and badly shook its credibility, macroeconomic fundamentals eroded, and what came to be known as policy paralysis punctured the romantic myths about the Indian economy as the silver lining in the recession-hit world economy.

The GDP growth was slowing dramatically. In the final two years of the UPA rule, it slowed from 8.1 per cent average growth during the preceding three years to 5 per cent during 2013-14 (the new GDP series subsequently revised this growth rate to 6.9 per cent). The economy had been beset by an alarming fall in the growth of manufacturing, services and agriculture sectors. Foreign direct investment fell, while the amount of corporate money fleeing the country reached alarming proportions thanks to the controversial moves of tightening of transfer pricing norms and introduction of retrospective taxation provisions in 2012. Denial of clearances and approvals on environmental and other grounds stalled big-ticket investment projects. Unacceptable levels of tax collection and the bloated subsidy bill hemorrhaged the government’s fiscal position. A spurt in lending without proper oversight soared non-performing and stressed assets, exacerbating the banking sector woes. Fiscal consolidation became an area of grave concern as the twin deficits—fiscal and current account—soared, prompting threats from international credit rating agencies that they would downgrade India’s status.

The flagging economy was the result of the larger crisis of governance. Every aspect of the state of the Indian economy underlined the necessity of bold reforms that would reignite domestic and foreign investor faith in the economy, revive growth, attract investment, repair fiscal imbalances, create jobs, curb inflation and boost the economy’s redistributive justice capacity.

It was in this setting that the Indian electorate voted out the UPA government and handed down the Narendra Modi-led Bharatiya Janata Party victory in the 2014 general elections. It was the first time in 30 years that a single party received a decisive mandate; the deeper meaning of it was the expectation that the reform-minded Modi will reshape the economy. India has voted unequivocally for hope and it voted in a Prime Minister who combines the capacity for good governance with resolute character. The change of government in 2014 has brought a new wave of optimism on the belief that the moment for India to make better progress on the kind of reforms that the country want—and deserve—has finally arrived.

As Arun Jaitley observed three months before he became Finance Minister in Modi government, strong political leadership that is capable of taking decisions and also implements them is key to India’s growth. “In order to gain and maintain high growth rate for this country, you need investments, larger economic activity, job creation and revenue. Large part of this revenue needs to be invested in infrastructure and poverty alleviation schemes. In economic terms, there is no difference of opinion, but in order to implement these, what is required is effective leadership to make a difference,” he said in February 2014, releasing Sameer Kochhar’s best-seller ModiNomics.

Big Dreams

Two important shifts in economic management have occurred in the last two years. Prime Minister Modi has cleansed the power corridors of corruption and distanced himself from industrialists, lobbyists and crony capitalists. He has also produced the sort of smash the economy badly required by setting the agenda for India for the next 10-20 years. The result was some big dreams—the Pradhan Mantri Jan Dhan Yojana (PMJDY) for financial inclusion and direct benefits transfer; Swachh Bharat Abhiyan (SBA) for a clean and hygienic nation; Make in India for manufacturing and infrastructure development; Digital India for e-Governance and strengthening administrative transparency and efficiency; Smart Cities for urban rejuvenation; Skilling India for skill development; and, Startup India for unleashing enterpreneurship. There were a string of social sector programmes and a plan to double the income of farmers by 2022, the year the nation will celebrate its 75th year of Independence.

The change of government in 2014 has brought a new wave of optimism on the belief that the moment for India to make better progress on the kind of reforms that the country want—and deserve—has finally arrived.

Starting with PMJDY, Modi and his team unveiled more than a dozen initiatives such Pradhan Mantri Suraksha Bima Yojana, Atal Pension Yojana, Pradhan Mantri Jeevan Jyoti Bima Yojana, Mudra scheme, Deen Dayal Upadhyaya Gramin Kaushal Yojana, Pradhan Mantri Krishi Sinchayee Yojana, Soil Health Card, Beti Bachao Beti Padhao, Pradhan Mantri Vidya Lakshmi Karyakram and the Pradhan Mantri Fasal Bima Yojana, the revamped crop insurance scheme announced in January 2016.

All these big dreams would converge and make India a $20 trillion economy from the present $2 trillion in the next two decades, eradicating poverty and making it a knowledge society. In January 2015, the Prime Minister had dared the country to dream about a $20 trillion economy.

Of these big dreams, PMJDY created history by providing new bank accounts to 11.5 crore households who have so far remained outside the banking network in just around six months after its launch in August 2014. Inspired by PMJDY, in 2015 it coined a term, JAM (Jan Dhan, Aadhaar, Mobiles) Trinity, to specify the new ecosystem to eliminate cash dealings between the government and the citizen in the transfer of social security benefits and subsidies. Jaitley, in his Budget speech in February 2015, called the JAM Trinity a “game changing” reform. By passing a law to provide statutory cover to Aadhaar in March this year was an important step to undergird JAM.

In Budget 2016-17, the government announced a health insurance scheme to protect one-third of India’s population against hospitalisation expenditure and a new initiative to ensure that BPL families are provided with a cooking gas connection supported by a government subsidy.

Fiscal Management

Its biggest feat on economic management was that it did not allow the economy to lurch to another slowdown, despite strong global headwinds. Moreover, it demonstrated laudable determination to stay within the fiscal deficit reduction targets, an unwavering spirit to follow through on JAM as the lynchpin for Direct Benefits Transfer (DBT) of government programmes as a tool to obtain massive savings on subsidies and commitment to persevere in social upliftment programmes by modifying many, such as the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) and crop insurance scheme and launching various others.

Yet, two years on, the claims about the pace of GDP growth slowdown in UPA-II’s final years and its reversal is mired in controversy. One myth the government had been perpetuating with very little press pushback was that the growth rate has “steadily climbed up” from where the UPA-II left off in 2013-14. This is what Arvind Panagariya, Vice Chairman, NITI Aayog, claimed in an article on 4 May 2016 in The Times of India. However, P Chidambaram, UPA’s Finance Minister from 2004 to 2008 and again from 2012 to 2014, in his weekly column in The Indian Express four days later, bristled at this assertion, asking how does the growth trajectory of the last two years—from the revised rates of 5.1 per cent in 2012-13 and 6.9 per cent in 2013-14 to 7.2 per cent and 7.6 per cent—constitute a “steady climb up”.

Chidambaram also disputed Panagariya’s statement that given “much change in policy” since 2014, “the miracle-level annual growth of 8.3 per cent that India saw from 2003-04 to 2011-12 is poised to return.” According to Chidambaram, the economy is “growing under a shadow of uncertainty” with no major reform by the current government.

Nevertheless, the former Finance Minister conceded that in its last two years, the UPA government was focused on putting a slowing economy back on track and to bring down the fiscal deficit from 5.73 per cent in 2011-12 to 4.43 per cent in 2013-14 and the current account deficit from $78 billion to $32 billion in the same period. Panagariya credited the UPA-I government for the “impressive” average growth rate of 8.4 per cent between 2004 and 2009, something which he had done in the past as well. In an essay entitled ‘India on the Growth Turnpike’ in the 2010 book of the same title edited by Sameer Kochhar, after praising the growth rates between 2003-04 and 2008-09, Panagariya hoped that “the country is almost certain to perform even better in the forthcoming years”.

But that was not to be. In his article on 4 May, Panagariya said the high growth rates—and the later slowdown—occurred despite the UPA-I and II governments’ failure to do major economic reform, an observation he did not make in his 2010 book article, and which Chidambaram pointedly refuted.

Why the Tepid Growth?

Anyway, the immediate task faced by the government in 2014 was to reduce the fiscal deficit and to ratchet up the growth rate. In two years of office, Finance Minister Jaitley has demonstrated his commitment to follow the Fiscal Responsibility and Budget Management (FRBM) Act path to cut the deficit target to 3 per cent by 2018. In the 2016-17 Budget, the Finance Minister said the fiscal deficit for 2015-16 will be maintained at the budgeted 3.9 per cent of GDP and 3.5 per cent for 2016-17. He announced a committee to review the FRBM Act to look into the feasibility of having a range for fiscal deficit targets instead of a set figure. The Economic Survey 2015-16 had advocated a review of the medium-term fiscal consolidation plan and recommended that the government “purchase insurance” against downside risks to the economy by increasing public investment rather than reducing the fiscal deficit.

In the first year of Modi government, the growth rate has inched up to 7.2 per cent in 2014-15 from 6.9 per cent in 2013-14 (the last year of UPA), as per Central Statistics Office’s new data series. In 2015-16, according to Advanced Estimate, the economy grew at 7.6 per cent.

In 2014-15 and 2015-16, the somewhat dampened economic growth was attributed mainly to global headwinds, decreased rural demand, agriculture sector deceleration and lack of bank credit growth. Some of the blame should rest with the hawkish, inflation-targeting monetary policy of the RBI. The central bank has hiked interest rates three times between September 2013 and January 2014 by 25 bps each. The resultant impact, some experts say, was that CPI inflation eased to 7.8 per cent by August 2014 from 9.5 per cent a year ago. A closer look, however, will depict different picture—the overall CPI inflation has eased because of moderation in food inflation from 11.1 per cent to 9.4 per cent during the same period. It’s a no-brainer that monetary policy has no impact on food prices and hence the perception that rate hikes have tamed inflation isn’t quite true.

The hawkish monetary policy stance affected growth and expansion plans of the corporate and MSME sectors alike. It is only from January 2015 that the central bank embarked on an easing cycle. The central bank has cut interest rates five times since then. In the fifth cut in April 2016, it slashed the rate by 25 basis points, lowering it to a five-year low of 6.5 per cent. Ensuring banks pass on those rate cuts, helping spur private investment, is now seen as vital to bolster the economy.

Inflation is expected to decline to a range of 4.5 per cent to 5 per cent in the 2016-17, within the RBI’s target, and the current account deficit is expected to stay low at 1.0 per cent to 1.5 per cent of GDP.

In a move widely applauded as a milestone in Centre-state relations, in February 2015, the government announced that it had accepted the recommendations of the Fourteenth Finance Commission and raised the states’ share in the net proceeds of Union tax revenues from 32 per cent to 42 per cent, a significant jump.

Following this, the 2015-16 Budget had affected a major change in the way the Union government spends its money. With more of its tax share going directly to states to spend at their discretion, the Union Government had begun reducing its allocations to the State Plan and began the long-overdue rationalisation of centrally sponsored schemes (CSS). The number of CSS fully sponsored by the Union government has been brought down to 27, which include the MGNREGS, Mid-Day Meal Scheme and Sarva Shiksha Abhiyan. Eight CSS have been delinked from support of the Centre and 24 others will now be run with the changed tax share pattern.

In October 2014, the government took advantage of the fall in oil global prices to decontrol diesel price fully, making it market-linked, which led to an immediate price cut of `3.5 per litre. The issue was politically sensitive so far and it was an excellent move by the Modi government. Although the Manmohan Singh government had in January 2013 announced that fuel marketing companies could raise diesel price by 50 paise a month to bring the administered price close to the market-determined price, the companies often did not exercise that right in the absence of a green signal from the oil ministry as global oil prices were still high. As crude oil prices were falling, it was the Modi government that found the most opportune moment to go the whole hog. The Modi government also came out with a new gas pricing formula that is much lesser than the one suggested by the Rangarajan committee under the UPA government.

Power Sector, Railways, Disinvestment

Three sectors give us a clue to the turnaround signals of the economy. In 2014, the power sector was in shambles, starved of investment and saddled with debt. In a bid to rescue almost bankrupt state electricity distribution companies, the Modi government in November 2015 unveiled a debt-recast and reform package called UDAY (Ujwal Discom Assurance Yojana). UDAY called for rejigging the `4.3 lakh crore debt of the utilities besides measures to cut power thefts and align consumer tariff with cost of generating electricity. UDAY is expected to remedy many of the ills plaguing the country’s power sector. Today, every power plant has adequate stocks of coal, in contrast to the final years of UPA when coal shortages had hit power generation hard.

In the first year of Modi government, the growth rate has inched up to 7.2 per cent in 2014-15 from 6.9 per cent in 2013-14, as per Central Statistics Office’s new data series. In 2015-16, according to Advanced Estimate, the economy grew at 7.6 per cent.

According to Power Minister Piyush Goyal, UDAY is a “comprehensive and game changing reform in power sector, which will result in savings of 1.8 lakh crore every year within three years from now. We brought rapid growth in power sector in the face of uncertainty on the coal front and launched ambitious programmes for new and renewable energy.”

He said the government’s focus has been on addressing the challenges before the sector in a more holistic and comprehensive manner but based on certain principles of governance. “We now have more than 26 days at an average of coal stocks in every plant in the country. No plant faces a coal crisis. We have also ensured coal stocks, which can feed another 30 days,” he said.

There is high degree of transparency. “The coal block auctions are a big example of that. India now has excess coal, excess power and is rapidly moving towards cleaning the environment by way of clean coal technologies, rightsizing of coal grids, a vigorous focus on renewable energy and honest procurement. The fact that we have been able to bring down the process of LED bulbs is widely recognised, for example. The entire decision-making process has been policy driven. In fact de-bureaucratisation and cutting red-tape has resulted in reducing the number of files that come up to me for approval from as high as 100 files a day when I had just become the Minister to not even five a day,” he added.

Railways is another sector where the new government has shaken up things. Railway Minister Suresh Prabhu told us recently that under-investment was a major problem that set Indian Railways back. “Railways was always dependent on support that it gets from Ministry of Finance, but the funds were not enough to address the serious infrastructure deficiencies. The new government successfully tapped the market to bridge the funding gap and broadened the managerial bandwidth to spend that money. We decided to press ahead with actual partnerships with private sector and state governments to improve railway infrastructure and facilities,” he claimed.

He said besides these, the Modi government has streamlined decision-making. “For example, the government for the first time delegated power to Board Members who, in turn, delegated powers to General Managers and DRMs and to the next functional level. We cut the tender cycle time of the project from conceptualisation to design. We moved all procurement through e-Tendering. A project that took 500 days for approval last year, took only 88 days this time. All those Railway Board files don’t come to the Minister now. Ease-of-doing business improves only when people believe decision-making is transparent,” he told INCLUSION.

During the UPA II government, disinvestment of public sector enterprises had all but stopped. However, the Modi government is intent on disinvestment with the same vigour with which the previous NDA government of Atal Bihari Vajpayee pursued it. In Budget 2016-17, Jaitley said, new policy for management of government investment in central public sector enterprises (CPSEs), including disinvestment and strategic sale, has been approved. The NITI Aayog will identify the CPSEs for strategic sale, he said, and announced that the Department of Disinvestment is being re-named as the Department of Investment and Public Asset Management (DIPAM).

Red Carpet To Foreign Investment

The Prime Minister has vowed to end era of “red tape” and instead roll out “red carpet” that is built on trust. Rewriting of foreign direct investment caps in almost all sectors, including those deemed sensitive, heralded further improvement in the business environment by means of improved regulation. Aggressive regulation of product markets hampers incentives for technological innovation and lowers the speed at which labour productivity catches up to the level of the best performing economies.

With private investment in construction ebbing, the government has done away with entry and exit barriers. For instance, area restriction and minimum capitalisation requirement of $5 million to be brought in within six months of commencement of business have been removed.

In a sweeping foreign investment reform initiative in November 2015, the government opened up several key sectors including defence, construction, civil aviation and media to foreign investment, eased norms for businesses such as single-brand retail and private banking and allowed the Foreign Investment Promotion Board (FIPB) to clear proposals up to Rs 5,000 crore from Rs 3,000 crore earlier.

In defence, the government has allowed foreign investment up to 49 per cent under the automatic route, earlier under the government approval route. Investments over 49 per cent will now be cleared by the FIPB instead of the Cabinet Committee on Security. Portfolio investors and foreign venture capital firms can also invest up to 49 per cent as against 24 per cent earlier.

FDI limits have been hiked in teleports (uplinking hubs), DTH (direct-to-home) and cable networks to 100 per cent with government approval required beyond 49 per cent. Further, news and current affairs TV channels and FM radio companies can now bring in up to 49 per cent FDI under the government route compared with 26 per cent earlier. For non-news and down-linking of TV channels, 100 per cent FDI has been permitted under the automatic route.

With private investment in construction ebbing, the government has done away with entry and exit barriers. For instance, area restriction (20,000 sqm) and minimum capitalisation requirement of $5 million to be brought in within six months of commencement of business have been removed. Further, foreign investors can exit and repatriate investments before a project is completed, but with a lock-in of three years.

In banking, the government has introduced full fungibility, meaning that foreign institutional investors, foreign portfolio investors and qualified foreign investors can now invest up to the sectoral limit of 74 per cent subject to the condition that there is no change in control and management of the private bank. Manufacturers have been allowed to sell their products through e-Commerce without government approval. Another major booster for single-brand multinational companies with 100 per cent FDI has come in the form of dilution in sourcing norms. Earlier, such companies had to ensure sourcing to the extent of 30 per cent of the value of goods from the date of FDI receipt. Now, it has been changed to opening of the first store. In case of “state-of-the-art” and “cutting-edge technology” ventures under the single-brand route, sourcing norms have been relaxed. Further, single-brand retail companies can also undertake e-Commerce business,
not allowed at present.

Future Challenges

The Economic Survey 2016-17 termed external environment as challenging but projected a 7-7.5 per cent economic growth rate in the next fiscal, which could accelerate to 8 per cent in a couple of years. However, it cautioned that if the world economy remained weak, India’s growth would face considerable headwinds. It noted that financial year 2016-17 will be “challenging” from a fiscal point of view. “So, credibility and optimality seem to argue for adhering to the 3.5 per cent of GDP target,” it said.

On the domestic side, two factors can boost consumption: increased spending from higher wages and allowances of government workers if the Seventh Pay Commission is implemented and return of normal monsoon. There are a couple of downside risks, too: slowdown in global economy might reduce its appetite for India’s exports; an upsurge in oil prices and the devastating risk would be combination of these two.

“One of the most critical short-term challenges confronting the Indian economy is the twin balance sheet problem—the impaired financial position of the public sector banks and some corporate houses. The twin balance sheet challenge is the major impediment to private investment and a full-fledged economic recovery,” the Survey cautioned. The Survey report flagged steps to broaden the country’s narrow tax base, including by not raising thresholds on tax breaks and phase out such exemptions.

“The twin balance sheet challenge is the major impediment to private investment and a full-fledged economic recovery. Comprehensively resolving this challenge would require four Rs: Recognition, Recapitalisation, Resolution and Reform,” it said.

The survey noted that free trade agreements (FTAs) implemented by India so far have pushed up imports more than the country’s exports. “FTAs have led to increased imports and exports, although the former has been greater… Increased trade has been more on the import than export side, most likely because India maintains relatively high tariffs and hence had larger tariff reductions than its FTA partners,” it said. Since the mid-2000s, India’s FTAs have doubled to about 42 today.

Two biggest failures of the government so far have been the inability to forge political consensus to pass the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement (Amendment) Bill, 2014, commonly known as the Land Acquisition Bill, 2014 and the Constitutional amendment to enable the implementation of the Goods and Service Tax (GST). Also, the disinvestment programme fell short of targets, including that of achieving strategic sales; and, the next stage of subsidy rationalisation is yet to happen.

All these big dreams would converge and make India a $20 trillion economy from the present $2 trillion in the next two decades, eradicating poverty and making it a knowledge society. In January 2015, the Prime Minister had dared the country to dream about it.

Political consensus on GST, implementation of which requires a Constitutional Amendment, has proved elusive. The Modi government has made several attempts to pass the Land Acquisition Bill. The changes the Bill sought included doing away with the need for taking prior consent from 70 per cent of affected families in case of land acquired for public private partnership projects and also undertaking a mandatory social impact assessment study within a six-month time frame. After resorting to ordinance three times and failing to pass it at the Rajya Sabha, where the government lacked majority, the government gave up on it in 2015. It dealt a huge setback to the government’s efforts to the Make in India plan.

Jaitley has rightly pointed out that reforms have become “absolutely necessary” in the areas of land, labour and taxes to attract investors. These are necessary to unleash the true potential of the Indian economy. With retrospective tax amendments undertaken to the Income Tax Act, 1961, through the Finance Act, 2012 continuing to rile foreign investors, the government has pledged look to address their concerns with a view to resolving the legacy issues and investors are waiting with bated breath on this.

The Modi government has to aim at 10 per cent plus growth in the long-term through radical reforms and deft implementation of its ambitious plans. The first uphill task ahead for team Modi is to revive the investment cycle. Modi’s tactful foreign policy must be backed by administrative and governance reforms to attract big doses of FDI in coming years, without which none of those big dreams—be it Digital India, Make in India or Startup India won’t bear fruit. Disinvestment of CPSEs should be accelerated and profitable PSUs should be asked to invest in related infrastructure that adds synergy in the operation—Coal India and SAIL, for instance, can invest in railways, ports and logistic projects to enable faster transportation of minerals from mines to industrial units.

The government needs to push for the comprehensive laws to ease labour law compliances. While full capital account convertibility may not be possible in a year, the government and RBI must open up the economy more to attract higher foreign investment and eventually make the rupee an international currency.

M Venkaiah Naidu, Urban Development, Housing and Urban Poverty Alleviation and Parliamentary Affairs Minister, told INCLUSION that the greatest achievement of this government was that the politics of poverty has been replaced by politics of development. “That is my conviction and

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