The economic slowdown now threatens to sink deep roots and become part of the economic landscape. There are various definitions of a recession and the state of the Indian economy seems to correspond closely with how the US’ National Bureau of Economic Research defines it: “Significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” Clearly, the sooner there is official acknowledgement of the “R” word, the faster remedial measures can be taken.
Various suggestions have been thrown around on how to revive the economy, or rekindle what Keynes famously called “animal spirits”. Finance minister Nirmala Sitharaman sang paeans to industry in her maiden budget speech, hoping to recharge investment demand. Even Prime Minister Narendra Modi, during his Independence Day speech, said wealth creators needed respect. This raises the $64-billion question: Is that enough to get private sector to resume investing?
The key to reviving investment or consumption demand perhaps lies in a 10-letter word: confidence. This term has special significance in macro-economic theory, apart from playing a critical role in shaping consumer expectations of the future, which then form the bedrock for current spending.
The tricky part is measuring the confidence of households and firms. The Reserve Bank of India’s quarterly surveys on consumer confidence, industrial outlook, households’ inflation expectations and industry’s order book, inventory and capacity utilization provide some assessment of these expectations. While there can be questions about the design-or even outcomes-of the survey, especially because households use subjective assessments of the economy and its future with regard to personal incomes or consumption patterns, there is vast literature now available on designing such surveys; plus, indices constructed on the basis of these surveys are found to act as suitable proxies of how households view future economic trends.
The RBI’s consumer confidence survey for the three months ended July 2019, conducted across 13 cities and 5,351 respondents, indicates that households feel the economy has worsened since the previous quarter, with expectations of further worsening in the future. In such a situation, households typically postpone spending till there are clear signs of an improvement. The signs of improvement depend on a combination of factors, which include inflation, income and employment.
A fresh jolt to confidence also seems to be in the offing. Bond yield curves across rich countries have started inverting, indicating that investors foresee greater stress in the near future than in the distant future. This trend was further accentuated on Wednesday with China and Germany reporting disappointing economic data. In a globally connected world, adverse economic trends travel from one geography to another through three channels: Trade, financial flows and confidence.
India now has to contend with not only domestic confidence shocks-accumulated over the years through inflation, a bruised credit market leading to credit-averse financial agents, demonetization, a faulty goods and services tax structure, industry feeling victimized, direct tax uncertainty, farm income compression and rising unemployment-but also those washing up from overseas economies.
So, how to get the confidence back? This is where intervention matters. If there was ever a time for decisive government involvement, it is now. There are two ways to achieve it. The first is to push public sector undertakings (PSUs) for asset creation: the reserves and surplus of 38 listed, non-financial PSUs rose 9% to ₹8.49 trillion in 2018-19. The government should use these funds for asset creation rather than balancing the fiscal deficit.
The second option is direct government engagement. A counter-cyclical fiscal policy is needed that favours expansion in times of a slowdown, but cuts back on expenditure during good times. At the heart of the logjam are amendments to the Fiscal Responsibility and Budget Management Act, 2003 (FRBM), introduced in 2018. These have squeezed government expenditure instead of redirecting it to productive uses.
The FRBM amendments have faced sharp criticism. Arvind Subramanian, former chief economic adviser and a member of the committee set up in 2017 to suggest amendments to the Act, had submitted a dissent note, which stated: “There are multiple targets on stock, flow, and composition, diffusing the focus, complicating communication and comprehension, and risking non-compliance. the new architecture would be a corset on fiscal policy, resulting in extreme procyclicality-aggravating booms and busts-with adverse effects on the economy.”
Beyond the critique, there is also a political-economy issue: Who benefits most from such a policy? Public policy design often benefits one set of stakeholders over others. It is true that unhindered debt accumulation by the state is not a desirable objective, but these are extraordinary times which call for extraordinary measures. The FRBM amendments have a built-in escape clause; the government should use it now while starting work on developing a more robust fiscal management framework.
Rajrishi Singhal is consulting editor of Mint. His Twitter handle is @rajrishisinghal.