Stepping up macroeconomy

The Modi government is heading to seek a renewal of mandate to implement its triple credo of perform, reform, and transform for another five years, beginning the summer of 2019, having subjected the economy to disruptive demonetisation in 2016 and a perfunctory placement of the goods and services tax (GST) in July 2017 as the acme of its economic reformist credentials in its maiden tenure. Though admirers and critics of the BJP-led National Democratic Alliance (NDA) have their own binary view of image, good or bad, of the Modi sarkar, the incontrovertible fact remains that the much-touted high growth potentials of the economy had not been duly exploited in the bygone years to make a qualitative difference to the living standards of innumerable Indians.

Against this backdrop, the staff appraisal report of the International Monetary Fund (IMF) released recently in Washington after the Board of the Directors met, makes quite an edifying reading. India is not under any loan programme of the IMF as of now and on the other hand it has been quite active as a responsible member of the G-20 in replenishing the Fund's kitty sans demur so that the lender of the last resort, as the IMF is viewed, could discharge its financing needs of members in stress and distress. Most of the published reports of the Fund referred to the positive features of India as one of the world's fastest-growing economies, accounting for about 15 per cent of global growth. The Indian elephant is about to run providing a permanent source of growth for the global economy in the coming decades, credited as it is with a young and growing population.

But the Fund, in its characteristic candidness, did not refrain from stating some stark facts pertaining to India's recent economic policies and how it would need to build on the limited success of its reforms. The Modi government might gloat over how it was able to flush out black money by demonetisation and bring out the vast swathe of taxpayers who were not paying their taxes for all their outlandish consumption. The admirers and critics of demonetisation fall in the twin categories of their opinion stated as good or bad, though many a thoughtful economist of the genre, like former Prime Minister Dr. Manmohan Singh, railed against it stating that it could shave off two per cent of the GDP growth figures. But now the jury is out as the Fund staff appraisal report minced no words when it said: "a surprise announcement in November 2016 to withdraw 87 per cent of currency in circulation introduced an acute monetary shock, exacerbating the growth slowdown that had started earlier". It went on to state that "the impact on growth appears to have been more severe and long-lasting than anticipated at the time of the 2017 Article IV consultation with a disproportionate impact on the informal sector". Given the national accounts revisions starting in the first quarter of 2017-18, growth slowed steadily by about 180 basis points from the announcement of demonetisation till May 2017, compared to about 100 basis points projected in the previous Article IV staff report, the IMF wryly stated. Lest the Indian authorities should view this blunt fact as too galling to gulp, as the Fund report hastened to qualify that digitalisation and formalisation objectives of demonetisation remain a work in progress.

Referring to yet another achievement due to the introduction of GST, the Fund report point blankly noted that transitional costs related to the national GST introduction led to a sharp slowdown of economic activity to 6 per cent year-on-year in the first half of 2017-18. While uniform tax rates across states is a major achievement, GST in India includes four non-zero tax rate tiers (and additional rates and cesses for specific goods) and a broad array of exemptions, such as on alcohol and petroleum, which goes against the Fund's suggestion of having as few tax rate tiers as possible with minimal exemptions. The point to ponder is not that the advent of GST has slowed growth, but its ham-handed implementation, having a multiplicity of rates and exemptions with venal interest to get rates lowered for their goods, muddied the otherwise good and simple tax as it should have been to usher in a win-win situation for all. Rightly, did the Fund call the bugle of vigilance in view of the higher-than-usual uncertainty shrouding GST revenue projections, stemming mainly from the absence of historical data to base projections on. In the context of GST adoption, the Centre has guaranteed states an annual revenue growth of 14 per cent for a span of five years. As such, GST revenue slippages could exacerbate the Central government deficit through additional transfers to states and warrants further fiscal measures.

On developments in the country's crucial banking industry, the Fund cautioned that the systemic macro-financial risks bear monitoring and the weak credit cycle could impair growth, while the sovereign-bank nexus has fostered vulnerabilities. Although bank credit growth recovered to 12.5 per cent (y/y) in May, incremental credit was mostly allocated to the household and the service sectors, with credit to industry remaining stagnant. Noting that the recent fraud at a large public sector bank viz. PNB highlighted governing hiatus, which has depressed bank share prices, the Fund warns that depressed valuations may make it difficult to meet the government's expectation that public sector banks raise an additional 0.3 per cent of GDP from the market over two years.

While commending the resolution of stressed assets of the banks and companies through Insolvency & Bankruptcy Code (IBC) and other cognate steps to clean up the twin balance sheet troubles, the Fund asked the domestic authorities to further beef up governance issues in the banking industry. But regrettably, the Banking Reforms Roadmap announced in January 2018, albeit linking recapitalisation of banks to strengthen governance and operations, is rather nebulous. In this context, the Fund urged the authorities to pursue more far-reaching governing reforms, for instance removing the RBI representatives from banks' boards and better defining the terms of reference for board members, including the Ministry of Finance representatives, to strengthen the quality and independence of banks' boards. More aggressive PSB disinvestment and privatisation would address some of the structural issues in governance, such as incentives and efficiency of PSBs, the Fund said.

In sum, the bitter medicines prescribed for bringing the banking sector back on track to do its core business of lending to the real sectors of the economy need a serious doctor from the political dispensation, one who understands the underlying implications of the cost of action and the fallout of inaction to the larger economy! IPA

(The author is a commentator on economic issues. The views expressed are strictly personal)