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Insights into Editorial: Breaking out of the middle-growth orbit


Insights into Editorial: Breaking out of the middle-growth orbit


Context:

Indian Prime Minister Narendra Modi is kicking off his second term in office with unwelcome news on the state of the country’s economy and the jobs market.

Government figures released showed India’s economy grew at a much-lower-than-expected 5.8 percent in the first three months of the year. That marks a sharp fall from the previous quarter, when growth clocked in at 6.6 percent.

Meanwhile, the unemployment rate rose to a multi-year high of 6.1 percent in the 2017-18 fiscal year.

The disappointing growth figures mean India is no longer the world’s fastest-growing economy.  For the first time in nearly two years, it has ceded that title to China, where the economy grows 6.4 percent in the first quarter.

 

Reasons for present Economic Slowdown:

Several indicators – automobile sales, rail freight, petroleum product consumption, domestic air traffic and imports – indicate a slowdown in domestic consumption.

Weaker consumer demand and slower growth in investments were blamed for the slowdown in India’s economy.

Private investment grew 7.2 percent in the March quarter, down from 8.4 percent in the previous quarter, while investment growth slowed to 3.6 percent from 10.6 percent, the data showed.

Economists said growth could slow further in the current quarter, the first of the fiscal year, citing weakening global growth as a factor leading to this decline.

The slowdown would “lead to pressures” for fiscal stimulus, including tax cuts on fuel products to boost consumption.

The government is already considering rolling out a slew of “big-bang” economic reforms in the first 100 days of Modi’s second term, with a focus on privatisation of state assets and relaxation of labour and land rules for businesses.

 

The farm sector contracted 0.1 percent in the March quarter compared with 2.7 percent growth in the previous quarter, while manufacturing grew 3.1 percent, slower than 6.7 percent in the previous quarter.

 

Dismal Picture of NBFC’s:

India’s non-banking financial companies (NBFC) sector is affected by a series of defaults by the Infrastructure Leasing & Financial Services (IL&FS) group of companies. The NBFC’s crisis has also been called as India’s “Lehman Moment”.

The main problem with the NBFCs is that they are facing Asset-Liability Mismatch in which they have taken short term loans (Liabilities) in order to lend money to long term infrastructure projects (Assets).

Over a period of time, the NBFCs have grown by leaps and bounds and have been able to cater to the credit needs of the Economy.

Hence, the crisis in the NBFC sector could have contagion impact on other sectors of the economy leading to further economic slowdown.

The RBI has so far refused the demand of the NBFCs to provide separate liquidity window.

 

Way Forward:

In order to streamline the GST regime:

The GST council should also think about decrease in the tax rates so as to promote consumption expenditure.

To reduce the complexity of the tax regime, there is a need to reduce the number of tax rates.

About 62% of the goods and services are now taxed at 18% which is rather high. Since the GST is a regressive tax, there is a need to reduce this tax rate to 12% in a phased manner.

 

Boost Consumption Expenditure:

In order to revive the consumption expenditure, the new government should focus on cutting down Income Tax and Corporate tax rates.

Such an approach would fulfil Government’s dual objective of increasing the consumption expenditure and boosting the Tax-GDP Ratio.

The Consumption Expenditure accounts for 60% of India’s GDP. The recent decline in the Consumption expenditure due to agrarian distress, unemployment etc has led to slowdown in Indian Economy.

This is evident in the decrease in the sale of passenger cars and two-wheelers, which have witnessed sharpest drop in the last 8 years.

 

Rescuing the NBFC’s at the Earliest to avoid contagion spread:

The new government must work with the RBI and must try to sort out the problems of NBFC’s at the earliest.

The central bank may have its own valid reasons for not conceding the demand but the truth is that there is a real crisis out there and a risk that the contagion will spread.

Usually it is the real sector’s problems that spread to the financial sector but in this case there is a real possibility of the reverse happening.

The new Finance Minister will have to work with the RBI and banks to resolve this issue at the earliest.

 

Conclusion:

The economic slowdown and high unemployment put pressure on present re-elected government and the central bank to stimulate the economy to boost growth and create more jobs.

The Reserve Bank of India is expected to reduce interest rates at its June meeting. Lower borrowing costs encourage consumers to buy more and businesses to produce more, which boosts growth.

It is time to get bold and reduce rates to spur consumption. Widening the basket and stricter enforcement are better ways to increase revenues compared to high rates.