As the economy teeters on the thin dividing line between a prolonged slowdown and recession, the debate continues to rage on whether the problem is structural or cyclical. The US – China trade dispute and the corona virus scare constitute global headwinds which have undoubtedly impacted the Indian economy. External shocks like demonetisation (along with the consequent effects on small business and real estate) and haphazard implementation of GST have also halted the economic momentum. However, these factors can at best be only a partial explanation to the much deeper malaise which lies within. Certain problems that our policymakers have been sidestepping for quite some time have come back to haunt us and these problems appear more structural than cyclical.

The decline in rural consumption has been greatly debated. The fact is that the growth in the services sector has for long camouflaged the weak underbelly of the Indian economy. 42% of the population is engaged in agriculture which contributes to just 14% of the GDP. In our attempts to play catch up with the rest of the world, we chose the easier and more expedient means of switching over from an agrarian economy to a service based economy. The need to develop the manufacturing sector was conveniently ignored by successive generations of policy makers as it would have involved making inconvenient decisions.

While the inevitable comparisons between the Chinese model and the Indian model do come up with monotonous regularity, the answers to our problems cannot lie in emulating the Chinese model. The Chinese model is a heavily flawed one but if there is one leaf that could be taken out of their book, it would be the systematic progression from agriculture to manufacturing to services and now to value added services (like cutting edge technology in telecom products and AI).

The agricultural sector has been long overdue for a second “Green Revolution” through innovations in bio-technology and irrigation techniques, changed cropping patterns, consolidation of small land holdings, altering the mix between food crops and other crop , considerable investments in supply chain and food processing and re-visiting price support mechanisms. However, the gains through all these initiatives could at best be considered incremental and certainly inadequate to address the problem of dipping rural income and disguised unemployment / underemployment which prevails in this sector. The answer clearly lies in creating capabilities in manufacturing and infrastructure (whose share in the GDP has remained stagnant for a very long time).

The convenient solution to the question of what ails the manufacturing sector usually ranges from poor infrastructure to high cost of funding. While these may be the generic truths, the question certainly deserves a more nuanced answer.

The cost of funds remains high because of high levels of government borrowing to fund fiscal deficits. Fiscal deficits for a limited period of time may be a great way to revive economic growth provided the borrowings are employed to finance investments in infrastructure and other real assets. These investments can generate sufficient returns over a period of time to enable the government to pay off the debt. Further, such investments can greatly facilitate manufacturing besides providing sustainable employment opportunities to rural labour and creating demand multipliers.

Instead, what we have seen over the last 7 decades is that the fiscal deficits have largely been used to fund unproductive expenditure (undoubtedly driven by the compulsions of electoral politics) with the result that the government invariably finds itself in a debt trap from where it is forced to borrow just to service interest on the existing debt. This creates a vicious cycle of high interest rates which adversely affects the cost of borrowing for corporate India.

Doing away with short term repo operations and replacing the same with long term repo operations may not really do much to lower interest rates if the government continues to rely on post office savings as a means to fund its expenditure. Higher rates on post office savings will compel the banks to keep fixed deposit rates at higher levels and this will in turn maintain continued pressure on the lending rates.

We have witnessed the widespread use of employment guarantee schemes to prop up rural income and consumption. It is important to ensure that such schemes are clearly linked to asset creation as otherwise any rise in rural disposable income will certainly not be a sustained one. Further, fiscal deficit may also be used to finance the expenditure on the re-skilling of the population as otherwise the rural population may not be able to make use of the opportunities created in infrastructure and manufacturing. While the private sector has been involved in such projects, it is nowhere near to attaining the scale where it can leave the desired impact. The initiative has to necessarily come from the government.

To a certain extent, the Indian business class is itself to blame because of the high level of borrowings to fund projects for fear of equity dilution and possible loss of control. This has led to extremely high levels of NPAs in the Indian banking system thereby constraining the ability of the banks to lend further. The resultant liquidity squeeze has also been compounded by the asset liability mismatch being faced by NBFCs who were vital cogs in financing small businesses as well as real estate.

A spate of measures announced over the last year or so (ranging from measures to ease liquidity to reduction in corporate tax rates) address only the supply side but do little to address the demand side. Where is the question of corporate India making fresh investments when the existing levels of capacity utilisation are less than optimum? Rather the tax savings will be used to de-leverage stressed balance sheets. Given the high levels of household debt and uncertainty on the job front, it is highly unlikely that any improvements in liquidity and softening of interest rates will actually spur household consumption.

To create sustained demand, one needs to create opportunities outside agriculture (which is currently facing maximum stress). The urban middle class is in a similar situation because of lack of opportunities for educated and skilled youngsters. The IT and ITes sector can at best provide employment to a limited pool of highly skilled workforce (and agrarian labour is ill – suited to be absorbed here) and that alone will not be enough to create enough multipliers. Same is the case with banking, insurance and financial services because these services exist to serve a middle class base as well as a corporate base which can only be sustained through considerable investments in manufacturing and infrastructure.

What can be done to create the right kind of environment for investments?

For starters, we need to have consistency on the policy front and respite from tax terrorism. The government needs to stop acting with the pre-conceived notion that all businessmen are corrupt just because of a few black sheep. It needs to live up to its promise of “minimum government, maximum governance”.

Secondly, we need to look at alternate financing mechanisms in infrastructure as commercial banks are clearly ill suited to this task. Maybe, we need to explore the idea of reviving development finance institutions which can provide long term finance to projects with long gestation period (the 2 existing bodies are clearly not equal to the task).

Thirdly, we need to really develop a very strong market for bonds, especially a secondary market. Both infrastructure and manufacturing companies can actually look at effectively tapping the bonds market. While the measures announced in the budget are encouraging, we still have a long way to go before we can lay our claim to having a well developed bond market.

Fourthly, the government needs to be less obsessed about meeting revenue targets and should instead focus more on ensuring that the government welfare expenditure is spent less on unproductive subsidies and more on creating assets which can provide sustained employment opportunities.
Fifthly, in order to overcome the problem of poor domestic demand, focus more on reducing the cost of export intensive sectors and create more opportunities by signing well balanced FTAs with major trading blocs.

Sixthly, there should be a clear separation of ownership and management in corporate India. This will ensure professionalism in business and ensure optimum utilisation of funds. This becomes all the more important when business is being carried on with debt funds (which are by and large public money) rather than equity.

Last, but not the least, can we have some degree of consensus amongst all political parties that economic policy making should be clearly divorced from the compulsions of electoral politics so that the long term health of the economy is not sacrificed through short-sighted policies aimed at electoral gains?