FinMin. Centre must steady the economy ship

Finance Minister Arun Jaitley has been holding meetings with his ministerial colleagues, Secretaries, and the Chief Economic Advisor to ascertain what the Centre can do to boost the steadily slowing economic growth.

The assumption here is that the third time’s the charm, and government intervention — unlike the first two times it tried it, with demonetisation and a hasty GST — will actually pay dividends.

The truth is that its own actions, and a poor global economy, have tied the government’s hands. There is nothing it can do, except ride out the storm. To illustrate this, let’s take the old, faithful formula for aggregate demand. Aggregate demand = C + I + G + (X – M). What looks complicated is actually common sense.

The formula basically says that the total demand in the economy is equal to the sum of consumption (C), private investment (I), government expenditure (G), and the difference between exports and imports (X – M). When broken up this way, it becomes clear that no additional steps can be taken to spark any of these sectors into action, and if they are, their effect will be marginal at best.

Over the last year, private consumption has been the one engine that has seen the economy achieve even the slow pace of growth it has. But a combination of demonetisation and GST has dampened the appetite for consumption to such an extent that companies are already preparing themselves for a poor showing in the festival season.

In any case, since so many companies ran aggressive and attractive clearance sales in the run-up to GST, consumers are unlikely in the coming months to flock to retail with their usual enthusiasm. What used to be a big bonanza come Diwali/Dusshera/Durga Puja time has now been dissipated. A slump in private investment is perhaps the biggest cause for worry here, especially since it is a persistent problem that will not go away without a comprehensive analysis of the situation and time-bound concrete steps being taken.

Companies invested heavily during the boom years just before the recession hit, and so, when the economy did slow down and demand receded, they found themselves saddled with the deadly combination of surplus capacity and debilitating loans. Neither will allow companies to increase their investments, so that engine of growth is not an option for a while.

The Reserve Bank of India can step in here and lower interest rates to try to boost consumption and investment, but that’ll result in marginal improvements since it’s not as if people and companies are not spending because loans are too expensive.

Exports, too, have been languishing due to weak global demand. Recently, with a strong rupee, imports have recovered somewhat, but the effect is just too small to really matter.

In such times, the recourse of choice is increasing government expenditure. That’s not going to work this time. Tax revenue, due to demonetisation as well as GST, has suffered, so the government does not have cash in hand to increase its spending. According to a recent Reuters report, the government is, in fact, considering cutting its expenditure due to poor revenue growth.

Add to this the untimely demand by the Opposition for the removal of the few taxes that are still remunerative — namely, the Excise duty on petrol and diesel. There are also calls for a ‘stimulus package’.

Not only does the government not have the money to spend, but it has set itself such strict fiscal deficit targets — of 3.2 per cent of GDP this year — that even if the money was there, it would find it difficult to spend it. The only option left is to borrow money to spend, which is a decidedly inferior option.

There is, in short, nothing the government can do for the economy except wait out the current sluggishness. The fact of the matter is that most of the pain of GST is being felt by the manufacturing sector, which accounts for less than 20 per cent of GDP. This monsoon has been relatively okay, and so agriculture will bounce back from the ravages of demonetisation, and services was never really affected.

It is good that Finance Minister Jaitley is trying to be proactive in trying to help the economy, but the best thing he can do right now is to run a steady ship and not change the GST rules often. Certainty about the future is perhaps the best medicine on offer right now.

COMMENT NOW