Macroeconomic stability is a precondition for growth. While, the key macroeconomic indicators pose no significant challenges at the moment, there’s never any room for complacency. Recent episodes such as the rupee’s fast-paced depreciation in 2018 are a useful reminder of how sudden shocks, such as on account of a spike in oil prices, quickly bring into play structural factors—of which the main factor is the economy’s dependence on net oil imports—sending macroeconomic parameters into the ‘worry’ zone.

The rupee depreciated by nearly six rupees to a dollar in a span of six months. It was about Rs 65 to a dollar in April in 2018. By September, it had depreciated to Rs. 71 to a dollar, despite the Reserve Bank of India’s heavy intervention. Months later, it remains at the just under Rs 70 to a dollar level. As a result, India’s current account deficit—the excess of imports over exports—for 2018-19 rose to 2.1 per cent of GDP, not an alarming level, but a six-year high nevertheless.

India’s relative external resilience stemming from strong foreign reserve buffers (equal to 7 months of current external payments) is balanced by the high public debt position. Total public sector borrowings are at nearly 9 per cent of GDP. Virtually all household financial savings, the chief pool of money from which the rest of the economy borrows, are going towards taking care of public sector borrowings, leaving very little for the private corporate sector and the small and medium enterprises.

Tax collections, meanwhile, fell short of targets in 2018-19 by 0.9 percent of GDP. The constraints forced the Union Budget to announce for the first time intentions of raising foreign currency-denominated debt overseas to fund rupee expenditure of the government.

Against this backdrop of a constrained fiscal position, ModiNomics 2.0 promises to follow an economic strategy that depends on increased public spending for delivering long-felt needs such as rural roads, toilets, tapped water, LPG, electricity, bank accounts, housing and small loans. While, the pro-poor strategy, instead of the previous pro-poverty one, has proved politically a winner, can it clock similar success economically as well?

Or, will the hard-won macroeconomic stability get disturbed once again by further increases in public borrowings necessary to finance the spending-led ModiNomics 2.0 agenda for bridging the India-Bharat divide?

Policy dilemmas and trade-offs of this sort are bound to dominate decision-making in the second Modi government’s tenure. He will have to reconcile conflicting compulsions and crying needs unfulfilled even seven decades after Independence.

First of these would be the management of tensions between the imperative of preserving macroeconomic stability and rising political expectations for public spending-led socio-economic policies.

Fiscal Math and Social Democracy

Despite achievements so far, the economy is underperforming compared to both our aspirations and its vast growth potential. This is true of both material and human development. In the three years from 2016-17 to 2018-19, GDP growth was 8.2 per cent, 7.2 per cent and 6.8 per cent. In the four quarters from April-June 2018 to January-March 2019, GDP growth slowed thus: 8.0 per cent, 7.0 per cent, 6.6 per cent. This means that in the course of four quarters, GDP growth slowed by 2.2 percentage points, a significant loss of economic momentum.

India has not been able to sustain 8 per cent-plus GDP growth over extended periods. The growth potential has fallen from 8 per cent a decade ago to 7 per cent now. Even in the high-growth years, though, jobs do not get created at a rate nearly enough to gainfully employ the vast numbers of youngsters entering the labour markets.

GDP growth has in fact failed to create jobs and, as French economist Thomas Piketty has shown in his well-received book, Capital in the twenty first century, disproportionately benefited a small section of the population only.

Unsurprisingly, there is growing impatience in the aspirational classes with the current pace of improvement of incomes and wellbeing.

Trickle-down economics has not worked. As the first speaker at the power panel on the Macroeconomic Agenda, Dr Ashwani Mahajan, National Co-Convener, Swadeshi Jagaran Manch, said, there is a case for moving away from what he called traditional obsessions in mainstream economics, and focusing instead on a charter of must-dos. 

Indeed, as Dr. Rajat Kathuria, Director & Chief Executive, Indian Council for Research on International Economic Relations (ICRIER), the second speaker on the panel said, also that the factor responsible for alleviating almost 140 million people out of poverty in India between 2004 and 2008 was growth. But what this shows is that growth is a necessary but not a sufficient condition for the Indian economy to become more inclusive.

To correct for the inability of the GDP growth to create jobs, and its tendency to sharpen economic inequalities, Modinomics is designed to be the economic agenda that takes into consideration the bottom 10 per cent of the people. It was started by the first Modi government involving direct transfer to the people of public provision of LPG, toilets etc.

In handing out a bigger mandate to Prime Minister Narendra Modi, the people have no doubt expressed confidence in his ability to take difficult steps necessary for overhauling the system necessary for delivering the ‘ache din’. They have also stamped their approval on the Modinomics strategy of public provision of basic necessities such as toilets and housing.

While there’s clearly a case for and the expansion of this strategy, the enduring challenge for the Modi government will be in bridging the gap between available resources and rising aspirations.

A tight fiscal position constraints further expansion of government spending. The Controller General of Accounts (CGA) figures show that direct tax collections in 2018-19 fell short of the Interim Budget’s revised estimates by Rs. 74,774 crore and indirect tax collections by Rs. 93,198 crore. The shortfall in the central government’s net tax revenues, thus, adds up to 0.9 per cent of the GDP.

There’s not getting away from the fact that the tax administration needs to be improved and the taxation policy and rates need to be rationalised. The draconian powers of tax administrators that include phone tapping and raids need to be re-examined. This needs to on the doable agenda list for the new government.

Institutional capacity remains the overall binding constraint but is even more acute on the resources side. The government managed to keep its fiscal deficit for the year under the budget target of 3.4 per cent of GDP by cutting expenditures and shifting the deficit to public sector entities. Off-budget financing is increasingly being relied upon.

The Food Corporation of India (FCI) took a substantial part of the food subsidy burden away from the Budget. The government delayed release of its reimbursements for the food subsidy, forcing it to increase its dependence on borrowings. The FCI’s borrowings from the National Small Savings Fund (NSSF) climbed from ?700 billion, as on end-March 2017 to ?1.86 trillion as on end-March 2019. Similarly, public sector enterprise ONGC’s cash reserves eroded 98 per cent from Rs. 2,385.98 crore as on March-end 2018 to Rs. 167.42 crore as on end-September 2018. The company’s financials were hit as it was made to acquire another government-owned company Hindustan Petroleum Corporation Ltd (HPCL) for Rs. 36,915 crore, as part of the government’s quest to raise revenues.

In this regard, the Modi government’s medium-term fiscal policy will attract sharper scrutiny from a rating perspective. A weak fiscal position continues to constrain India’s sovereign ratings and as it is, modest fiscal slippage relative to the central government’s own targets has resulted in a stalling of fiscal consolidation in recent years.

The cumulative fiscal deficit of the central government and the state governments has remained broadly stable at around 7 per cent of GDP in the past five years. As a consequence, the general government debt increased to 68.8 per cent of GDP in 2018-19 from 67.1 per cent in 2013-14.

The government’s borrowings place excessive claims on the financial savings of the economy. Banks are not in a position to transmit the RBI’s three consecutive cuts of 25 basis points each in policy rates during the current calendar year into lending rates because the cost of deposits, a prime source of lendable funds, remains unchanged.

In May, the average interest rate offered on term deposits with a maturity of more than one year remained at 6.9 per cent for the sixth consecutive month. With the growth in savings of households slowing, growth in aggregate bank deposits also fell to 9.7 per cent in April 2019 from 10.0 per cent in March 2019. In FY18, household sector’s net financial savings fell by 3 per cent points of GDP.

The reason monetary policy is not transmitting more fully is because of a fiscal overhang. If the fiscal deficit expands, yields will inevitably harden and further undermine monetary transmission, thereby making any fiscal expansion, at least partially, counter-productive.

The resources crunch then is real. But increased public spending needed to finance Modinomics 2.0 can still be carried out without upsetting the macroeconomic stability. 

Finding Capital for Growth

There is a sense that the cost of capital is very high in India. The demand is thus for cuts in the Reserve Bank of India’s policy rates. But that’s just one variable that goes into the cost of capital. 

Dr. Mahajan said, the Reserve Bank of India’s single-minded focus on hiking interest rates to tame inflation has slowed inflation much more than is desirable, and even growth is slowing. Lower policy rates from the RBI are a must to spur growth in the country.

But, as explained above in the previous section, household financial savings are not keeping pace with the government and rest of the economy’s growing needs for borrowings.

In these circumstances, the third speaker, Dr Charan Singh’s, Distinguished Fellow, SKOCH Development Foundation and Non-Executive Chairman, Punjab & Sind Bank, ideas come in handy in addressing the issue of where the capital to finance growth could come from.

The growth of savings of households, the largest source of lendable resources through the banking channel, to government and industry, has declined for very specific reasons.

When the economy suddenly slowed down from 9 per cent growth to 6-7 per cent growth for no fault of its but because of disturbances in the western world in the form of the global financial crisis of 2008 that resulted in a global economic downturn subsequently, and for fifteen consecutive months, Indian exports suffered, then this would naturally reflect in incomes. Savings come out of incomes. India will have to increase incomes and savings.

The trend of young workers seeking loans against their next-month salaries to finance consumption, as highlighted by Rohan Kochar in the discussion, confirms the slowdown in household savings.

If India could have diversified in the domestic market and hinterland at point in time, as Modinomics now seeks to do, the situation may have been different today.

Anyhow, it was not done, and rate of growth of incomes, and consequently, savings have suffered. Also, because of the impact of the global economic downturn, and the policy paralysis that had hit the UPA government, banks are not in the pink of health.

Consequent to the global slowdown, the corporate world received a shock and its loan repayments suffered. Banks are still recovering from that shock.

In addition, banks’ ability to lend is squeezed by the fact that they follow Basel norms that were created in western countries, suited to the conditions there. Banks raise money at a cost, but the norms prevent them from lending it, adding further to the cost of money.

Of the 21 banks in the country, only five have international branches. Banks with foreign branches need to follow the Basel norms to be able to compete globally but should the other banks have to follow these norms for risk-weighted capital, he asked, that are very restrictive. If India creates its own norms and indicators, it will release capital for stimulating credit growth and, as a consequence, GDP growth. GDP growth improve tax collections. Plus, the pressure will also ease on the domestic debt market, which will reduce lending rates, creating additional fiscal space for the government. 

For this, Indians norms are needed for Indian banks, many of which have been in existence for more than 100 years. Basel norms were created in countries where banks never survive for longer than 10-25 years. But many Indian banks are older than 100 years and survived the world wars, the partition and the great recession.

New national capital adequacy norms, therefore, could be one instrument for meeting the people’s aspirations and the country’s duties and responsibilities towards those without worsening the fiscal balance.

To create further fiscal room, household savings will have to grow fast. Alternatively, the savings of households locked up in the housing sector and automobiles, must be released. Both these sectors are not performing well.

The housing sector encapsulates 270 ancillary industries. When it stagnates, these 270 industries slowdown. Similarly, in the automobile industry a 100 industries play a role. And, the automobile industry is holding 400 per cent inventory of what they normally hold. So, incomes are again impacted.

The government should focus on releasing the holding of capital in housing and in automobiles. There is a simple way to do it. Say 1 lakh houses are currently stuck and the value of each is say Rs. 40 lakh. Then, the amount of money stuck is heavy. To unblock it, stamp duty holiday for one and a half year should be considered.

Some states have 12 per cent stamp duty and others have 7 per cent. The central government can make it a uniform 2 per cent across the country for a window of a year and a half. Business will start again as soon as people start selling houses. This can lead to more savings and more business and more income.

Job Generative Growth

Next, comes the question of how to make GDP growth more jobs generative. This section will examine the specific steps and measures required to be taken so that growth in the economy is qualitatively different than in the past— it also drives jobs creation.

The government of course cannot – and should not – absorb more and more job seekers into the lower rungs of state machinery. Because that only increases the fiscal deficit, and in a way that is qualitatively not desirable.

Fact is, the way out is for India is to create jobs and growth together. India’s model of GDP growth is failing to create a sufficient number of productive employment opportunities to gainfully employ the large number of entrants into the working-age population.

To create jobs, private investments are needed. And the obstacles in way of setting up of new businesses and expansion of existing ones need to be removed so that new jobs can get created. For this the policy constraints need to be identified and removed. Confidence in predictability of policies, as elaborated by the Economic Survey presented on July 3, 2019, needs to be improved. The regressive steps taken on financial regulation, tax policy and capital controls have led to a capital flight out of India, need to be reversed.

If somehow the slack from the farms could be drawn away from the farms and trained and skilled so that they can be absorbed into the formal manufacturing and services sector jobs, this would be doable. The disincentives that make companies prefer high-cost capital, despite India being a labour-abundant economy, need to, therefore, be removed.

What will it take for the formal sector to pursue more labour-intensive production of goods and services than at present? Clearly, amendments to labour laws. An important initiative of the Modi Government is labour reforms, as highlighted by the Budget speech on July 5, 2019.

The Union Cabinet headed by the prime minister, just ahead of the presentation of the Union Budget, approved changes to the labour code and the wage code. It remains to be seen what all amendment were approved by the Cabinet ahead of the presentation of the budget speech that also made a reference to upcoming changes planned in the labour code and the wage code.

What needs to be done in the Indian context is known but it is the political economy that comes in way of implementation. Labour-intensive manufacturing has to be at the core of the agenda. But Indian labour laws have protected workers but not protected jobs.

It is politically difficult but the goal for India has to create jobs. We cannot go on protecting the workers that are engaged in the formal sector. For that national consensus will have to evolved on what needs to be done to correct for this failure.

This group – the workers that are engaged in the formal sector – represents barely 6.5 per cent of employment in the formal sector. Because there is no incentive to employee workers, even the formal jobs are getting contractualised.

Take the example of the shoot-out a few years back in a Maruti factor that symbolised the protests of the ‘outsider’ workers against the ‘insider’ workers because for doing the same job they were receiving two-third the wages that the latter were getting. Because of the labour laws, companies are willing to substitute capital for use of labour and, therefore, jobs are not getting created. As a result, the Indian textile industry, a labour-intensive industry, is more capital intensive than Bangladesh and China.

The NITI Aayog and the government want to make labour laws flexible. Although, as Dr. Kathuria said, flexibility should not mean throwing the workers under the bus and their rights, benefits and security need to be suitably protected. But the old model of growth where only workers are getting protected, and jobs are not created will have to be discarded.

As Dr. Rakesh Mohan, Former Deputy Governor, RBI, had said in his keynote address, the labour laws have created disincentives for Indian firms to grow in size. India has failed to evolve a labour-incentive model of growth for structural transformation that every other country has in creating a manufacturing sector that generates jobs. Korea, China, Japan, even Europe did this successfully. Not India. We can’t go on protecting workers in the formal sector when most people are not in the formal sector, he said.

So, the problems of jobless growth is not one of not knowing what to do, but one of knowing how to do it, given the political economy’s realities.
It will become increasingly difficult for India in the future because a manufacturing industry cannot be expected to become competitive without being also in the exports market. And, so participation in the global economy is an imperative.

There are many other factors contributing to jobless growth besides the labour markets. There are many constraints on development that you will keep hitting constraints one after another. This includes tariffs. The policy package must include ways of incentivising firms that are vacating China to come to India to set up manufacturing units.

Although, as Dr. Mahajan said, Indian tariffs can be and should be calibrated and used to own advantage. But shutting ourselves away from globalisation is not an option. The anti-globalisation seen in the world today, if deconstructed, is actually anti-immigration and anti-inequality. India has to use globalisation to our advantage, another view all panellists veered to by the end of the discussion.

True, even the original proponents of it, advanced countries in the west, are arguing against globalisation today and raising tariffs on imports from India and China. Although, India is being forced to throw open its markets to MNCs and drop tariffs to imports. This was hurting local manufacturing. Recent rounds of hikes in Indian tariffs on Chinese imports have shown that some corrections are in order. The hikes have helped reduce India’s trade deficit with China, Dr. Mahajan said.

But as, R Adm L V Sarat Babu, NM, IN(Retd), Chairman & Managing Director, Hindustan Shipyard Ltd, said, globalisation can play a significant role in India’s economic future. A shipyard such as the one he heads has multiple divisions, such as for ship repairing, submarine repairing, ship building. The company engages start-ups and Medium Small and Micro Enterprises (MSMEs) for various functions. It employs a range of workers from sanitary workers to high-skill engineers.

Since MSMEs can create employment and at the same time address poverty, the overriding consensus among the speakers was that a clear-sighted focus on this sector is needed. The clear agenda that had emerged from the discussions all morning was that MSMEs can be the source of poverty alleviation, growth and jobs.

Rohan Kochhar, Director, Public Policy, SKOCH Group, highlighted how technical skills are largely gained at the workplace in MSMEs. But as soon as the interns are trained and gain some work experience, they get poached by the larger companies, turning the MSMSs’ investments into the technical training of the workforce entrants a cost that does not generate returns.

The 63.38 million MSMEs in India contribute 40 per cent of India’s manufacturing output, 45 per cent of exports, 28 per cent to GDP and provide employment to 111 million people, doing it all at a very low capital cost. And yet, he said, that what happens is that as soon as employees hired from campuses become trained, learning on the job in MSMEs, they get poached by deep-pocketed bigger companies.

A national apprenticeship mission where each worker is paid compensation by the government for a year during which they learn on the job could help solve this drain of resources from the MSMEs to the bigger companies, he said. The main reason this is needed is because the education system does not produce employable workers and on-job learning is required.

Examples of other countries shows that, such as in Korea, 88 per cent of the employment is provided by the MSME sector. China’s thrust of providing suitable policy environment is best seen in case study of the Shenzhen Municipal Corporation where $3 million worth of subsidies and support are provided to specialised companies. Why should India not remove the regulatory and policy bottlenecks hampering MSMEs’ growth?

If policy makers focus more on capital issues, although India is a labour-abundant country with a jobs crisis, it’s because only 450 MSMEs are listed on the stock exchanges. 
Access to capital needs to increase exponentially for MSMEs without which the segment will always be constrained in its capacity to grow. As the U.K. Sinha committee has said, a relook of the 2006 legislation on MSMEs needs to also examine if all the various laws governing the segment can be consolidated into an updated code.

Dr. Mahajan said, policies, according to him, are made with MNCs in mind with the hope that they will drive growth and generate job opportunities. This must be changed as growth and jobs won’t come from big firms and corporate entities. But they can come from MSMEs and small scale enterprises.

For MSMEs to become a driver of growth, jobs and development, they will have to be provided funds, opportunities and skilled employable people. Of these, opportunities can only be provide by major capital or other large stable and labour-intensive industries. Such as ship-building, chemical manufacturing, automobiles and housing industries.

Only when these industries grow, the ecosystem around them will grow and the start-ups and MSMEs will growth. This is because they are dependent on the large industries. R Adm L V Sarat Babu said that government stipulation says that minimum outsourcing from MSMEs by Hindustan Shipyard Ltd has to be to the tune of 20 per cent of turnover, but many companies are doing 40 per cent.

So, facilitating growth of large capital industry is key to MSME growth.

Today, industrial contribution to GDP growth is less than 24 per cent, which is less than what any developing country that expects to become a developed country in the near future should be satisfied with. It should be as much as what the services sector is contributing. For this, the government may decide to give subsidies to specific large industries, but those will have to be competitive globally. Since by nature these projects are long-gestation, the government will have to define the products needed over the next two-three decades in order for them to deliver the products and the consequent growth in the ecosystem that is dependent on the industry.

Financial Sector Governance

For these business units to grow, be institutionalised and formalised, the goals of the Modi government, MSMEs need a way to access scarce capital. For this to happen, the system must have greater trust in MSMEs. Equally, the smaller companies’ financial literacy needs to be improved. Small companies do not at times know what avenues exist for them to tap capital.

A binding constraint on the growth of MSMEs is their limited recourse to sources of capital because of the prevalence of collateralised lending.

Group Managing Director, Pantomath Capital Advisors Private Limited, Mr Mahavir Lunawat, highlighted the Banks and non-banking financial companies demand the collateral of fixed deposits to extend loans for working capital needs or overdraft facilities.

The ecosystem of the Indian financial system needs to move away from collateralised to projects-based funding. Despite all the noise about availability of loans for MSMEs, these are largely loans against properties and collateral rather than business loans.

Similarly, insurance treasuries and other financiers stay away from participating in MSME equity ownership.