Fiscal, monetary options largely exhausted, structural reforms critical to push GDP growth

The sharp deterioration in economic activity in Q1FY20 and continued slowdown through August suggests the Indian economy faces structural challenges in certain sectors and cyclical slowdown in others linked to a drag by some sectors with structural issues. Structural reforms will be crucial to bring about a change in real GDP growth rates.

India’s agriculture model is quite challenged with raising demand-supply imbalances, leading to stagnant farm prices and incomes, which have necessitated farm income schemes from the government. High consolidated fiscal deficit and strained balance sheets of infrastructure companies have constrained investment rates.

Low growth in household income may be the primary reason for the current slowdown in consumption, which in turn reflects structural problems in the economy linked to limited number of secure jobs being created in the formal sectors and meaningful disruption in parts of the informal economy due to demonetisation, GST implantation and NBFC-related funding challenges as also stagnant farm incomes.

Households may have continued to consume disproportionately to their growth in income in spite of low income growth resulting in rising share of consumption to GDP. However, households perhaps no longer feel confident about consuming given sharp falls in household savings and general negative headline news.

The government has low capacity to provide meaningful fiscal stimulus to the economy, given faltering tax revenues and stagnant GST revenues although they seem to mulling rate cuts for auto sector. The government may have to compromise on fiscal targets to provide stimulus unless it raises large amounts of funds through a well-articulated privatization program. RBI may cut rates by another 50-75 bps, although its efficacy remains to be seen. Interest rates have stayed stubbornly high with the government’s small savings funds program distorting household savings.

Structural reforms will be critical for higher GDP growth as the government may have largely exhausted the fiscal and monetary options unlike previous periods of slowdown in the economy when it had more ammunition to fight the slowdown.

In particular, structural reforms in investments and lower role of government in the economy seem imperative to put India on the path of higher and sustainable GDP growth. Investment-related reforms in manufacturing covering various factors of production like land and labour and faster approval process will be key to low-cost labour-intensive manufacturing and reforms in infrastructure covering areas of ownership of infrastructure assets and pricing services will be important for greater role of private sector and more sustainable investment models.

There is an over-reliance on government entities for investment in infrastructure, which results in lower than optimal investment rates for the economy given the fiscal constraints. Also, the government may want to review its direct role in the economy through PSUs and government agencies, since they are generally inefficient operators versus their private counterparts with several consumer centric businesses making losses, structural constraint for innovation due to high employee costs, and lack of resources due to fiscal constraints.

The government may have to consider large-scale privatisation to fund its infrastructure funding requirements. There may be a need to resolve around ownership below 51 per cent to execute this plan.