H I G H L I G H T S
• In spite of recovery, growth set to elude India in 2020-21
• Govt finances show the stress, but they are getting better
• Opening up banking to corporates raises hackles of experts
• Extending PLI scheme to 10 sectors: A double-edged sword?
• Stimulus III: Fiscal cost contained within Rs 1.2 trillion
In spite of recovery, growth set to elude India in 2020-21
For two successive quarters, the Indian economy has shrunk and technically is in recession, but it is on a recovery path. The first quarter saw 23.9 per cent contraction, but the second quarter showed a contraction of a much lower 7.5 per cent. This is better than even the RBI’s advance assessment of 8.6 per cent contraction presented earlier this month. For the first half of the current year, the economy saw a contraction of 15.7 per cent. In nominal terms, the contraction was 13.3 per cent in the first half.
What does this mean for the full year ending March 2021? The Indian economy contracting for the full year now is certain. If GDP in real terms has to stay in a positive growth territory, the economy has to expand by over 15 per cent in each of the remaining two quarters of the year, in real terms. Is that likely? In the second half of 2019-20, the Indian economy grew by 3.28 per cent. The question is: Will there be such a dramatic recovery in the economy to help it register a four-times increase in the growth rate over what was recorded in 2019-20? That clearly looks unlikely.The debate now is on what the extent of the contraction will be for the full year.
In nominal terms, the optimists could still entertain some hope. If nominal growth is over 13.56 per cent in each of the remaining two quarters of the year, then the current year’s nominal growth could be positive or the size of the Indian economy could be at least more than Rs 203 trillion, which it was at the end of March 2020. Nominal growth includes the impact of inflation. Retail inflation is now ranging quite high at over 7 per cent. In 2019-20, the nominal growth rate in the second half of the year was just 6.43 per cent. Could the nominal growth rate in the second half this year be double the rate seen last year?
In the end, a real growth rate of over 15 per cent and a nominal growth rate of over 13 per cent look unattainable in the last two quarters of 2020-21. This is a message that cannot be ignored, even though there is now clear evidence that the economy is on a steady path of recovery.
What helped the economy bring down its contraction rate in the July-September quarter of 2020? The manufacturing sector helped. It has returned to the positive zone for the first time in many quarters – after four consecutive quarters of contraction starting in the second quarter of last financial year. The growth rate of 0.6 per cent is small, but it is a sign of hope after a massive contraction of 39 per cent in the first quarter. Agriculture continued to be the economy’s saviour with another healthy rate of growth of over 3 per cent, staying above that level for five consecutive quarters in the past. But the second quarter of the current year was also helped by the electricity sector, which returned to a positive growth territory after a contraction of 7 per cent in the first quarter.
The worrying sign was the construction, hotels and the financial sector, which continued to remain in the negative zone. Public administration stayed in contraction mode, reflecting how the government has not allowed a runaway rise in its expenditure. This is also confirmed in the numbers for government final consumption expenditure, which continued to shrink though at a lower pace. It shrank from 18 per cent in the first quarter to 10 per cent of GDP in the second quarter.
What about the investment outlook? The gross fixed capital formation numbers have risen smartly in the second quarter to 29 per cent of GDP, up from 22 per cent in the first quarter. This is a trend change after the investment rate having declined for the past two consecutive quarters. If this trend is maintained, it would certainly help sustain the growth that everyone is looking forward to in the coming quarters.
Govt finances show the stress, but they are getting better
The Union government’s finances are reflecting a gradual recovery in the economy. While the headline fiscal deficit number for the first seven months of 2020-21 shows the stress, both on the tax revenue and expenditure fronts, there are signs of the government beginning to get a hold of the situation.
The fiscal deficit number for April-October 2020 is now estimated at Rs 9.53 trillion, almost 120 per cent of the Budgeted fiscal deficit of Rs 7.96 trillion. But this comparison may be a little misleading. Remember that, anticipating a revenue shortfall and expenditure increase because of Covid-19 and the economic lockdown, the government had already armed itself with additional borrowing of about Rs 4.2 trillion. Thus, the total government borrowing or the expected fiscal deficit this year would be about Rs 12.2 trillion.
Now, compare the fiscal deficit figure of Rs 9.53 trillion against the revised fiscal deficit figure of Rs 12.2 trillion. It turns out that the government in the first seven months of the financial year has exhausted only 78 per cent of the already-approved fiscal deficit for the full year.
Last year, the comparable figure was 77 per cent. By the end of October 2019, the government had run up a fiscal deficit of Rs 7.21 trillion against the actual fiscal deficit of Rs 9.35 trillion for the full year. No doubt, the fiscal deficit in 2020-21 will be more than double the figure of 3.5 per cent of GDP, promised in the Budget presented in February 2020. But the cushion of enhanced borrowing has helped the government pay its bills and reduced uncertainty. The brakes applied by the government on its expenditure and a mild recovery in tax revenues have also helped.
The Union government’s total expenditure was reined in at Rs 16.61 trillion, just about 55 per cent of the annual estimate it had given in the Budget. Last year at the same time, the government had spent about 59 per cent of its annual budgeted expenditure. The expenditure saving has taken place on account of both revenue expenditure and capital expenditure. Compared to the same period last year, the increase in the Union government’s total expenditure this year is just 0.4 per cent. In the Budget, total expenditure was expected to rise by 13 per cent over last year.
The Centre’s gross tax revenues continue to be a cause for concern. At Rs 8.76 trillion in April-October 2020, the collections are just about 36 per cent of the annual target. Last year, at the same time, gross tax revenue collections at Rs 10.52 trillion were 52 per cent of the actual annual collections. More worrying are receipts under non-tax revenues and disinvestment of the government’s equity in public sector undertakings. The disinvestment target for the full year was Rs 2.1 trillion, but the collections at the end of the first seven months are a little less than Rs 62 billion. Similarly, non-tax revenues at Rs 1.16 trillion in the same period in the current year are just about 30 per cent of the annual target.
The big challenge for the government in the remaining five months of the current financial year is to manage the obvious pressure of growing expenditure now, needed as part of the stimulus measures. Even if the revenues pick up in the latter half of the current year, the shortfall in the total receipts would be huge. Given the current trends, there is a possibility of the government needing to go in for additional borrowing, over and above what has already been planned. A wider fiscal deficit is less of a worry, compared to the challenges of managing the extra borrowing without creating any instability in the bond market.
Opening up banking to corporates raises hackles of experts
Never before in recent times a proposal from an experts’ group has evoked such strong protests as did a specific recommendation of an internal working group of the Reserve Bank of India (RBI). The RBI group, in its report made public on November 20, suggested major changes in bank ownership. If accepted and implemented through an amendment to the Banking Regulation Act of 1949, these recommendations would allow large companies and industrial houses to own banks. For the last many decades in India, the ownership of banks by companies and industrial houses remains prohibited.
The experts’ group also suggested that large non-banking financial companies (NBFC) with an asset size of over Rs 500 billion and a track record of at least a decade could be allowed to be converted into banks. There are at present at least 14 such NBFCs (many of them owned by industrial houses or companies), which could effectively convert themselves into banks, if the recommendations are accepted and implemented. The same group also suggested many other changes like raising the cap for promoters of banks to 26 per cent and for non-promoters to 15 per cent, subject to RBI'S clearance. Similarly, the group recommended that the capital requirement for those applying for a universal bank licence should be doubled to Rs 10 billion. The capital requirement for small finance banks should also be raised from Rs 2 billion to Rs 3 billion, the experts’ group recommended.
But the general commentary on the recommendations of the experts’ group is primarily focused on its specific recommendation on allowing industrial houses and companies to own banks and is uniformly critical of the move. And the opposition has come from three former chief economic advisors (one of them was with the Modi government), one finance secretary, a former governor of the RBI and also a former deputy governor of the RBI. More such voices from other former functionaries in the government and the RBI are not ruled out. The broad point they make is that the move would be dangerous and disastrous. The three adverse outcomes they fear are: “over-financing of risky activities, encouraging inefficiency by delaying or prolonging exit and entrenching dominance”. They have also pointed out that if companies have an in-house bank, they can get finance easily with no questions asked. “How can the bank make good loans when it is owned by the borrower”, asks one of those criticisin the move. Another strong reason cited to oppose the entry of industrial houses into banking is that it would “further exacerbate the concentration of economic (and political) power in certain business houses. According to one of them, the move could lead to crony capitalism and eventual financial instability. Only a foolhardy and imprudent government can afford to go ahead with a proposal without evaluating why this proposal has been roundly opposed by eminent experts like Shankar Acharya, Vijay Kelkar, Kaushik Basu, Arvind Subramanian, Raghuram Rajan and Viral Acharya!
Extending PLI scheme to 10 sectors: A double-edged sword?
Another potentially controversial move of the government was the announcement of extension of the Production Linked Incentive (PLI) on November 10 to ten more sectors with an additional outlay of about Rs 1.46 trillion over the next five years. Already this scheme had been introduced for mobile and pharmaceuticals manufacturing. Now, the ten sectors to be covered under the PLI schemes include advance chemistry cell battery, electronic products, automobiles and auto components, pharmaceuticals and drugs, telecom and networking products, textile products, food products, high-efficiency solar photovoltaic modules, white goods like air-conditioners and specialty steel. The scheme envisages that fresh investments leading to higher production would be getting cash incentives at the rate of 4-6 per cent of incremental sales. The scheme would be implemented and monitored by different administrative ministries. The financial allocations to pay for the incentives for each of the ten sectors are flexible in the sense that the unused portion of the money for one sector can be diverted to anther sector in need for such funds. While on paper the scheme is expected to give a boost to investment in the identified sectors, but its implications for the government subsidy and encouragement of a discretionary regime to be run by bureaucrats could turn out to be serious long-term handicaps. The government has to be closely monitoring its implementation to prevent it from becoming a drag on government finances and encouragement to inefficiencies within the government and outside. Worse, the scheme could encourage industry to demand more tariff barriers to ensure its success.
Stimulus III: Fiscal cost contained within Rs 1.2 trillion
On November 12, Finance Minister Nirmala Sitharaman unveiled the third package of stimulus measures to help the Indian economy fight the adverse impact of Covid-19 and the economic lockdown that followed. But as in the previous two packages, the fiscal cost is relatively small. The earlier packages cost the exchequer about Rs 2 trillion. The estimated actual cost for Stimulus-III will be Rs 1.2 trillion in the current year. The various measures under the latest package were aimed at addressing stresses and concerns in the key sectors of medium and small enterprises, rural infrastructure, infrastructure, rural jobs and the agriculture sector. Indeed, the largest amount of the package was earmarked for fertiliser subsidy.
An amount of Rs 650 billion was additionally provided to provide subsidies for fertilisers. In the current year, the usage of fertilisers is expected to increase by 18 per cent to 67.3 million tonnes, largely due to favourable monsoons and an increase in the sowing area. The Budget for 2020-21 had provided a total amount of Rs 713 billion for fertiliser subsidy. But by the end of October, as much as Rs 608 billion has already been disbursed, leaving just about Rs 104 billion for the remaining months of the year. The extra allocation of Rs 650 billion will not only help meet the demand for more fertilisers this year, but also help clear the past dues. Fertiliser companies, too, should be celebrating, as its dues would be cleared without any delay or uncertainty.
The government had earlier announced an emergency credit line guarantee scheme (ECLGS) for providing collateral-free and guaranteed loans to micro, small and medium enterprises (MSME), individuals having taken loans for businesses and borrowers from the Micro Units Development & Refinance Agency (MUDFRA). This was done to help them absorb the adverse impact of Covid-19 and the economic lockdown. A total loan amount of Rs 3 trillion was to be provided under the ECLGS. About Rs 2 trillion under this scheme has already been sanctioned for 6.1 million borrowers and an amount of Rs 1.56 trillion has already ben disbursed. Now the ECLGS has been extended till the end of March 2021 and the amount under it could be used also for units under the 26 stressed sectors identified earlier by a committee headed by former ICICI Bank head K.V. Kamath. The tenor of the loans under ECLGS is five years, with one year’s moratorium on principal repayment.
The Modi government’s Stimulus-III has many more schemes. A provision of Rs 102 billion is being provided for making available capital for industrial infrastructure, incentives for industrial production and domestic defence equipment. An extra allocation of Rs 180 billion is being made to help build houses under the Pradhan Mantri Awas Yojana. An equity infusion of Rs 60 billion for a debt platform of the National Infrastructure Investment Fund will help boost infrastructure projects, with the help of more borrowing. Another Rs 100 billion is being provided for creating rural employment. Rural India continues to remain the focus of the Indian government in the wake of COVID-19 and the economic lockdown.
(The views expressed are personal)