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View: What's the biggest likely risk to Modi's $5 trillion GDP goal?

For perspective, it took us nearly a decade to go from about $1 trillion to $3 trillion.

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Last Updated: Jan 22, 2020, 03.05 PM IST
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Dipti's quote
Tthe financial sector clean-up bodes well for the long term. But in the short-term, the stress feeds into real sector and slows growth.
By Dipti Deshpande

In fiscal 2020, India’s economy grew 5% in real terms – the slowest in 11 years. In nominal terms, the size of the GDP is almost $3 trillion – or $2 trillion short of the touted goal.

For perspective, it took us nearly a decade to go from about $1 trillion to $3 trillion.

This time, the window is less than four fiscals. That means India will have to more than double its current growth rate in these years, to about 10% per year in real terms, with some inflation and stable exchange rate.

Monetary and fiscal policies can only bring about a short-term revival in the economy through a demand boost. But to increase the ‘trend’ or ‘potential’ growth rate, would require a much bigger reforms push and an improvement in global trade.

Fiscal pressures have intensified already, limiting the government’s ability to stimulate growth. And continuing financial sector woes is delaying a pick-up. If that weren’t enough, the ongoing global slowdown is also a material constraint.

There is little the Union Budget for fiscal 2020-21 can do to address the latter two. On the fiscal side, though, anything can be on the table.

So far, monetary policy has almost single-handedly attempted to revive growth but with moderate success as transmission of interest rate cuts to the real economy remains weak. This has put the onus on fiscal policy to trigger short-term growth.

As things stand, there appears neither room to spend extravagantly nor the possibility of drastically reducing tax rates. Government borrowings have already surged in recent years keeping bond yields high. Because these yields act as a benchmark, other interest rates in the economy, too, have risen or stayed high despite the recent monetary easing. Any further rise in borrowings will, therefore, put more pressure on yields and crowd out private sector borrowing.

Yet, if the goal is to kick-start growth, then breaching the fiscal deficit temporarily to spur consumption is an option.

But such moves in the past have been unsustainable and raised domestic macro vulnerability. To avoid a repeat, the government should use additional fiscal space, if any, to push capex or spend in sectors where the income multipliers are higher. But this will not immediately yield a growth surge. The government in the budget will need to spur consumption by augmenting incomes in the rural areas where the propensity to spend is higher.

The stepping up of NREGA and rural construction works is one way to do so. Also, improving the effectiveness of ongoing schemes and spends under the PM Kisan scheme to enhance its reach is the other option available to the Budget when the fiscal hands are tied.

Problem is, this may push the $5 trillion goal further.

As for the financial sector, stress has spread from banks to non-banks, and credit growth has declined sharply. This is due to weak credit demand, shortage of liquidity with some lenders, and risk aversion. Banks, for instance, are parking a larger proportion of their loanable funds in government securities which are risk free and are also giving higher yields.

The slowdown in credit growth, therefore, reflects both macroeconomic challenges (which have constrained loan demand) and tighter loan supply by banks. The stress among non-banks is also hurting credit growth. Given the high penetration of non-banks in certain household-consumption segments, the stress is constraining demand further. The Budget can do little to address this.

To be sure, the financial sector clean-up bodes well for the long term. But in the short-term, the stress feeds into real sector and slows growth.

There’s some way to go before things improve materially.

The kind of clean-up initiated in the financial system has not been attempted in India earlier, and entails radical improvement in transparency (through restructuring of bad loans) and focus on improving credit culture. The short-term cost of such a clean-up is slower growth.

The global economy is confronting many uncertainties and risks – trade and geopolitical tensions being the biggest. This has weighed on consumption and investment demand globally, too, causing growth to slip. Though the US-China trade tensions have not directly hurt India, indirect consequences have been significant.

Typically, in periods of high global economic and trade growth, India has benefited through its exports sector. During the mid-2000s, when global growth was ~5% and trade growth ~7% per year, India’s exports grew about 24-26% on average. After the global financial crisis, when many countries stimulated demand, economies and trade grew rapidly, lifting India’s boat, too.

Global growth has slowed to 3% in calendar 2019, the slowest since the global financial crisis of 2008 and 2009. Ditto trade growth.

Importantly, prospects for next five years look no better than the last five, with growth set to average 3.5%. So the flank of exports is unlikely to deliver unless India improves its competitiveness drastically.

The upshot? The path to $5 trillion will be gradual, and three things have to happen: growth momentum picks up and sustains; there is a material revival in consumption; and, private sector investment cycle kickstarts, backed by reforms.

A blockbuster Budget and daring follow-throughs can be the perfect start for this.

( The writer is Senior Economist, CRISIL. View expressed are personal)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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