GS-3, Indian Economy

Adequacy of Counter Measures against Economic Slowdown

The counter measures declared by the Union Government against the economic slowdown may not be adequate for a revival of the economy.

The Role of Fiscal Policy in Economics:

  • In 2005, a Nobel laureate in economics claimed that the fiscal policy, associated with profligacy, had no role at all and the problem of depression has been solved.
  • A few years later, the S. fiscal deficit raised three-fold and the world fall into an economic slowdown.
  • Then he stated that it is alright to rely on fiscal policy in the face of an impending crisis.

Factors of Higher Growth Rate:

  • Our experience of the five years of very high growth over 2003-08, when the economy grew at its fastest ever, tells us that three factors had played a role in it.
  • Unusually high rates of agricultural growth.
  • Record levels of public investment.
  • Higher level of exports.

The State of Economy in India:

  • After the Budget had been presented, the government met industrialists for policy inputs.
  • Some of the tax proposals were rolled back in a press conference held a few weeks later.
  • The government revealed its anxiety about the state of the economy.
  • At present, India has an economy in which growth has been declining for close to two and a half years.

Counter Measures taken by the Government:

  • Three sets of announcements were made by the Finance Minister recently:

1. Concessions impacting upon the automobile sector.

2. Proposals for the banking sector.

  • Infusion of capital upto ₹70,000 Cr. into the public sector banks is one of the most significant measures related to banking. This is expected to contribute to a potential ₹5 lakh Cr. expansion of credit.
  • A proposal to ensure that loan decisions taken by bankers are treated as economic decisions and not as instances of corruption when a loan goes awry.
  • There was the announcement that public sector banks will pass on more of the policy rate cuts that the Reserve Bank of India (RBI) has effected in several rounds.

3. Change in the practice of the Income Tax (IT) Department regarding the procedure adopted for issuing an IT notice.

Are the Counter Measures Adequate?

  • Addressing the problems of any one sector (automobiles) when several are equally stressed is not fair governance.
  • There have been reports of severe stress in the agricultural sector, packaged foods industry, etc.
  • Change brought in for IT notice could address the issue of tax terrorism.
  • But only a thorough social audit of the processes adopted by the tax authorities can establish whether it would be sufficient to ensure that honest firms are not suffering and that the government receives all the revenue due to it.
  • Industrialists are under pressure to not speak out against government officials.
  • The compulsory retirement of income tax personnel for malpractice recently point to not everything being well within that department.
  • Some of the proposals for the banking sector are quite sound.
  • But, if the government’s intention was to reverse the slowing of growth they are unlikely to make much of a difference.
  • Public sector banking has been hobbled by the colonial attitude that India’s public servants cannot be trusted.
  • It leads to a continuous surveillance that is not conducive to their exercising initiative in lending.
  • At the same time, the non-performing assets (NPA) crisis points to the role of political pressure on banks in the past.

Other Challenges:

  • Even if the lending rates are set to be lowered, it may not revive the economy.
  • Generally, the potential of monetary policy in reversing sluggishness in the economy is considered to be weak.
  • There is a belief among economists that a rise in the rate of interest can hold back a decision to invest by raising the cost of finance.
  • On the other hand, an interest rate reduction can do little in the absence of an urge among investors to commit capital.
  • A lack of understanding of the factors governing investment is evident in the suggestion often seen in the press that the government must ‘revive animal spirits’ in the economy.
  • Animal spirits were originally imagined as the spontaneous urge to either undertake investment or hold back from it.
  • The expectation of future profits is the key element here for potential investors.
  • The government can have a role only if it can affect long-term profit expectations.
  • The government accepts that the economy needs more growth but insists that this can only come via private investment.
  • But the private sector awaits an improvement in growth before deciding whether to invest.
  • The package announced by the Finance Minister did not relate to either agriculture, public investment or export.
  • Exports depend to an equal extent on factors beyond India’s control. But the government could have addressed the other two factors.
  • It had nothing for the rural sector as well, which clearly needs attention.
  • The government is reluctant to step up public investment because of fiscal constraints.

Way Forward:

  • A proposal for a near-automatic adjustment of public sector banks passing on the policy rate cuts announced by the Reserve Bank of India (RBI) is welcome.
  • But, the banks are worried about the risk attached to some loans. The risk premium based on their prime lending rate, which itself depends on factors other than the policy rate.
  • The decision should be left to the banks.
  • Government needs to take proactive steps focusing on private investment.
  • Long term infusion of capital in the banking sector should have been accompanied by governance reforms enforcing honest behaviour and secure the public banks from political pressure.
  • There should be an expansion of the Mahatma Gandhi National Rural Employment Guarantee Scheme, with attention paid to building assets that most strongly impact agricultural output.
  • Government should increase public investment by managing the fiscal constraints.

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