Indian Economy: Time to unlock the true potential

India’s GDP data for the quarter ending June 2020 was released last week and with it the fear of a massive contraction came true. The GDP contracted nearly 24%. The contraction is the country’s biggest in decades and the worst second-quarter decline among the world’s top five economies.

Source: TradingEconomics.com/Ministry of Statistics and Program Implementation

India’s agricultural sector grew 3.4% in the second quarter, compared with the same period last year, but besides that, the results in other sectors affected by the lockdown was severe.

Engines of growth:

In any economy, the total demand for goods and services — that is the GDP — is generated by the four engines of growth.

GDP = C+I+G+NX

1. C = Private Consumption (Consumption by individuals) For India “C”was the main driver with contribution around 56.4% to the GDP in the pre-pandemic period.
2. I = Private sector business investment . This accounted for 32% of the Indian GDP in the pre-pandemic period.
3. G = Government spending which accounts for around 11% of the GDP.
4. NX = Net exports (Exports — Imports). In India’s case, it is the smallest engine and, since India typically imports more than it exports, its effect is usually negative on the GDP.

Source: Ministry of Statistics and Program Implementation

The top two engines of growth, Private Consumption and Business Investment which account for nearly 88% of GDP, contracted the most, -27% and -47% respectively. This shows the imposition of the lockdown dealt a heavy blow to the consumer demand in India. As consumers were quarantined at home, businesses drastically cut back on investments. The NX or the net export demand has turned positive in this Q1 because India’s imports have crashed more than its exports. A majority of it is due to drop in fuel imports. While this looks good on paper as it provides a boost to overall GDP, but we must also take into account that exports also crashed.

That brings us to the last engine of growth — the government spending. As the data shows, government’s expenditure went up by 16% but this was not sufficient enough to compensate for the loss of Consumer demand and Business Investment.

Looking at the absolute numbers gives a clearer picture. When the demand from C and I fell by Rs 10,64,803 crore, the government’s spending increased by just Rs 68,387 crore. In other words, government’s spending increased but it was so meagre that it could cover just 6% of the total fall in demand being experienced by people and businesses.

Contraction across sectors:

With GDP contracting by more than what most observers expected, a look at key indicators in the different sectors highlight a stark reality.

Source: Ministry of Statistics and Program Implementation

The decline in cement, coal and steel clearly illustrates that construction (–50%), trade, hotels and other services (–47%), manufacturing (–39%), and mining (–23%) were the worst affected sectors. It is important to note that these are the sectors that create the maximum new jobs in the country particularly unskilled labour. In a scenario where each of these sectors contracted so sharply due to the lockdown imposed by the Government, millions of people lost their livelihood and were forced to return to their home states.

Unlock the potential :

Given the severe blows that the virus has dealt to both lives and livelihoods in India, getting GDP growth back on the fast track may seem like a tall order. Yet India in the past particularly in 1991, has been able to rise to such challenges, to introduce strong and sustained reforms spurred by a crisis. It can do so again, provided it rallies around a sharply-defined reform agenda based on forward-looking opportunities. The alternative is potentially a decade of stagnation, with low income growth and rising unemployment.

Mckinsey has outlined in its report 3 growth boosters across 43 high productivity opportunities which could contribute $2.5 Trillion to the economy by 2030.

1. India as a hub for manufacturing and services: This has the potential to provide almost $1 Trillion in value by 2030. In order to take advantage of the opportunities presented by the trade war between US and China, rising wages in other Asian hubs and rational desire to streamline supply chain, India needs to do more reforms and make itself the preferred choice of firms. In this regard India announced in September 2019, its decision to historically cut Corporate Tax to 22% from 30%. The new corporate tax rate for domestic companies, excluding surcharges, makes India more competitive than neighboring Bangladesh and puts it almost on par with Vietnam and Thailand, countries that have wooed businesses affected by the U.S.-China trade dispute.
2. Improve efficiencies in key sectors: Innovate solutions and adoption of technology can eliminate inefficiency in areas that underpin a competitive economy: power, logistics, financial services, automation, and government services. In each case, opportunities for value-creating market-based models could emerge, generating about $865 billion in economic value by 2030. For example Fintech solutions, power distribution reforms and automation in manufacturing.
3. Tapping new ways of working and living: Indian businesses can create economic value of about $635 billion by 2030 if they can tap into the shifting preferences of Indians aspiring to a higher standard of living. Safer, higher-quality urban environments, cleaner air and water, more convenience-based services, and more independent work in the new ideas-based economy are all opportunities to create millions of productive jobs in service sectors.

Conclusion:

Reforms is the key

The damage to the economy has been brutal. Factories are closed and millions have lost jobs. In view of the gloomy circumstances and uncertainty ahead the consumption and investment cycle are frozen.

In such a scenario, the Government has to do most of the heavy lifting by spending in infrastructure projects and doing reforms to revive the economy. The Government did announce several reforms in May 2020 pertaining to relaxing rules for investment in key sectors such as Defence, Mineral, Mining, Aviation, Power etc which are definitely good moves in the right direction. The Government should take advantage of the current fallout due to COVID-19 and push through reforms which were put in the back burner earlier due to lack of consensus.

The five key reforms which has the potential to add tremendous value are:

• Reforms in Retail and Agro Supply Chains:

India is home to a large middle class which has aspirations to have global products and consume the best in the world. The Government should not only encourage e-commerce but also allow foreign direct investment in retail. This is a politically sensitive issue as millions of small stores fear being losing out to multinationals with deep pockets. The reaction is overrated and misses the value add such a move would bring in streamlining the supply chain from producer to seller. It has the potential to create thousands of jobs as unorganized and fragmented retail would give way to a more organized sector.

• Land Reforms:

Land acquisition in India has always been politicized with political parties opposing it to garner votes. In the past and present several new projects are pending at different stages since hitting the land acquisition roadblock. This has inflated home construction projects as scarcity of land drives prices high leading to high costs of the finished apartments for buyers. For companies, high-cost land puts a brake on expanding productive capacity and they prefer to move to other destinations.

The Government needs to bite the bullet and bring in the reforms. It did the right thing by reducing tax on new manufacturing but now it has to make land acquisition hassle free.

• Labour Reforms:

Along with land its important to have labour reforms. This has been a bottleneck for decades. A growing population bringing millions into the work force every year needs millions of jobs to be created every year. Firms would be skeptical to hire aggressively if they see it as a liability. Currently smaller manufacturing units prefer to remain to avoid labour restrictions which come into play as the man power increases. A labour policy which would provide adequate protection to the worker and also not burden the owner with compliances should be devised.

• Privatization:

The socialist economic model which India adopted post independence led to the creation of several state owned firms across sectors. These firms were mainly used in the past to generate employment at the cost of productivity. Gradually over the years the Government has realized the futility to remain a shareholder in many such firms. It started the disinvestment drive with much fun fare two decades ago. Every year the Government announces plan to divest Government shareholding in public sector firms and every year it falls short of its target. Its important to monetize government-owned assets and increase efficiency through privatization of state-owned enterprises (SOEs)

• Cut red tape further:

India has made significant progress in the World Bank rankings for ease of doing business since 2016; the country rose from 130th overall in 2016 to 63rd in 2020. However, Indian firms still face several obstacles ranging from delayed payments for public procurement to tedious and slow processes for obtaining permits. For example Construction permits take much longer in India than in peer emerging markets. A single window clearance for upcoming projects should be done at the state level for faster turnaround.