The road India must take after May 23

By Ajay ChhibberAs India is preoccupied with its election, the world is getting more and more uncertain and volatile. Two global developments may have huge impact on India: the trade spat between China and the US now shows signs of becoming a full-scale trade war; the removal of Iran oil purchase waivers and the prospect of rising tensions in the Gulf and elsewhere make India’s oil options more difficult.A new Indian government will need to navigate through these uncertainties as it tries to revive private investment and a slump in exports as the consumption-led growth of the last two years begins to lose steam — as any consumption-led spurt always does. Despite the likelihood that the Bimal Jalan Committee will recommend transferring extra reserves from RBI to the finance ministry, a government spending-led recovery will be difficult as the unbudgeted invoices of huge election-related giveaways will need to be paid. State finances are also in a precarious state.Get the Basics RightOur research shows that the key determinants of private investment are the real exchange rate, credit available to the private sector, public investment and capacity utilisation. Public investment could be boosted by aggressively selling public sector utilities (PSUs) and earmarking those funds to the National Investment and Infrastructure Fund (NIIF) — and not frittered away in the revenue budget. Capacity utilisation is finally picking up, as is credit to the private sector.The injection of capital into public sector banks (PSBs) through recap bonds has provided some headroom for commercial lending. The banking sector remains impaired by the non-performing assets (NPA) problem. There was hope that the Insolvency and Bankruptcy Code (IBC) would help resolve this. IBC is a good reform but is not designed to address a systemic NPA problem quickly. Serious reform of the banking system remains for the future.One of the most important variables that affects private investment and exports is the real effective exchange rate (Reer). Reer has appreciated by about 15% over the last five years. This is largely due to the very high interest rates that the new monetary policy framework has introduced. RBI’s repo rate over the last five years has averaged 6.7% and the actual consumer price index (CPI) has averaged 4.4%, realising a real repo rate of 2.3%. The main reason for such high repo rates has been RBI’s inflation expectations that have averaged 5.7% over the same period.The monetary policy framework gives primacy to inflation over growth and employment, and should be reviewed. It also produces this persistent bias of overestimating inflation expectations. The new RBI governor has lowered rates but, for now, they still remain too high. If inflation remains low, further cuts in interest rates to encourage private consumption and to reduce the overvaluation of the exchange rate are needed.Correcting the rupee overvaluation of 10-15% will be necessary, but not sufficient to boost exports. Export promotion must take on a war footing as rising oil prices will hurt India’s balance of payments. India’s share in global markets remains tiny, giving us huge opportunities to increase export despite the slowdown in global trade growth. Free-trade agreements with Asean also need to reviewed and expanded into the services sector where India has comparative advantage.Attracting FDI, which is leaving China for other locations, and entering global value chains must be given special priority as the China-US trade war heats up further. Relaxing labour laws will be crucial to boost India’s competitiveness.Finding stable oil supplies at reasonable prices holds the key to India’s prosperity as the country remains hugely vulnerable to oil price swings. Non-dollar-based oil purchase arrangements must be pursued aggressively to avoid vulnerability to sanctions.Green Shoots on the FarmsThe biggest boost to growth and employment immediately can come from the services sector, especially in tourism and mobility services. A cheaper rupee will help tourism. But India must review its tourism policy on a much more comprehensive basis. The tax rate on hotels, the poor state of infrastructure in tourist sites, which can be addressed by creating special tourist policing arrangements, must be considered, especially for women. Encouraging the mobility and e-commerce sector holds great promise also for attracting FDI.Both PM-Kisan and MGNREGA hold key to alleviating rural distress, and expanding productivity. But the funding needed if these schemes are to be expanded must come from removing wasteful subsidies in electricity and fertilisers that are now hurting agricultural productivity. Free electricity is helping create a water crisis and leading to uncompetitive cropping patterns. The current PM-Kisan scheme must be expanded to provide more direct income support to smaller farmers, and MGNREGA must be funded to provide at least 100 days of employment to help reduce distress.Any new government will also have to focus on the social sectors: the quality of education and skilling, expanding basic health, ensuring Ayushman Bharat gets properly implemented, and addressing air pollution and climate change. These must be given high priority. The immediate need is to revive the economy and create employment in a competitive manner, while handling global uncertainties and geopolitical fault lines.Businessman-politician Gary Johnson said it best, ‘Regardless of who wins, an election should be a time for optimism and fresh approaches.’ Let’s hope that despite the bitter rhetoric of a campaign, India takes that path post-election.The writer is visiting scholar, Institute for International Economic Policy, George Washington University, US

from Economic Times http://bit.ly/2W7Yi4O