The Indian economy is on track to achieve 10% -/+ 1% GDP growth with downward bias as we had projected a year ago, reiterated in early 2021, and re-evaluated after the second wave of Covid-19. Prior to the Omicron variant, we had narrowed the forecast uncertainty to +/- 0.5%, but the arrival of the new variant returns the uncertainty band back to 1% with downward bias.
The second quarter GDP data and IIP suggest that recovery to FY2019 levels is stronger in fixed investment than in private consumption. Within private consumption, nondurables are close to 2019 levels. The trade deficit has expanded due to sharp recovery in gold imports and oil prices despite high export growth. The latter will slow because of slower global demand, but Indian economy will continue to grow due to supply chain diversification. The impact on trade deficit will be limited due to oil price moderation.
Almost 18 months ago, we had pointed to the simultaneous existence of excess demand and inflation pressures in some commodities and geographies and excess supply and deflation in others during the transition from pandemic to normalcy. The extended transition due to repeated Covid-19 waves in the US and lockdowns in China was, however, not anticipated. The interaction of these factors with the large stimulus in the US has disrupted logistics much more than was anticipated a year ago. However, the localised imbalances within India and to a lesser extent within Europe has played out more in line with our analysis.
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Reforms in Indian economy
The structural reforms undertaken by the Narendra Modi government since September 2019 were projected by us to put Indian economy on a fast growth track by FY22 with a forecast growth rate of 7.5% +/- 0.5% (7% to 8%). This is being increasingly recognised by private analysts with the two-year GDP growth rate rising to our projection of 17.5%, though their pattern of growth in each year differs.
There has also been speculation on the effect of repeal of farm laws on other reforms. With 45% of workers associated in some way with agriculture, farmers are the biggest political interest group. The next largest political interest group, organised labour, is less than 8% of the workforce, while other interest groups are a fraction of 1% of the total workforce. Therefore, the effect on other reforms will be minimal. That said, it is wise to time and phase reforms carefully to minimise economic and social disruption.
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Concerns, weakness and Budget 2022
Recovery of the informal, non-agricultural sector of the Indian economy seems to be lagging. Though there is a paucity of specific data, there are indicators. The slow recovery in private consumption and the low level of consumer confidence as shown in RBI’s consumer confidence survey. Another indicator is the declining trend in rural non-agricultural to agricultural wage, indicating slow growth of income.
Though part of this is temporary and will recover with the recovery of contact services like retail trade, hotels, restaurants, tourism and hospitality, some may contribute to the trend decline in the share of informal sector. The share of informal sector in India’s economy is too high and must decline as formalisation accelerates. However, it is essential to ensure that modern MSMEs have a level playing field relative to domestic and foreign corporates.
The forthcoming Budget 2022 must focus on tax reforms and rules needed to ensure a reduction in cost of doing business by MSMEs which generate the majority of new jobs. This requires reform and simplification of the Direct Tax Code, GST and Import tariffs/duties.
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Direct Tax Code: Draft of a simple, rational tax code incorporating global best practices was approved at the last formal meeting I attended as the chief economic advisor in October 2009. A committee appointed by the Narendra Modi government has thoroughly reviewed and debated its provisions and given its report. Only legislative action is pending. This is critical to lower the cost of doing business for MSMEs subject to corporate law which was reformed in September 2019.
Import Duties: The dispersion of import tariffs is too high, for instance there are dozens of specific rates in textiles. These distort incentives from efficient protection through misclassification and excessive imports. The average tariff rate also increased from 13.8% in 2018 to 17.6% in 2019. These rates have already been reduced to 15% in 2020, but need to be reduced further to 12.5-13.5%. This will boost exports of labour-intensive goods and facilitate integration with MNC supply chains through which a majority of global exports occur.
GST: A dramatic simplification of GST, with 3/4th of goods and services having a uniform rate of 15% and no cess, without worrying about a decline in revenues in the first year will provide a boost to consumption and MSMEs, and raise revenue buoyancy. Exemptions should be limited to basic food, basic education and basic health services. To ensure revenue neutrality in the second year, a higher 25% rate and cess, should be levied only on automobiles and tobacco products.
The Omicron variant of Covid-19 has again raised the downside risk to global GDP, and indirectly through demand for our exports and FDI in supply chain diversification. Once this risk is resolved, monetary policy stance should be restored from accommodative to neutral. This is likely to take another month or two. So, monetary policy is likely to remain unchanged at the next meeting of RBI monetary policy committee.
(Arvind Virmani is Chairman of EGROW Foundation, a Noida-based think tank. He is a former chief economic adviser to the finance ministry. This article is a reproduction of his presentation at EGROW Foundation’s shadow MPC meeting held on December 3.)