Modi 2.0: Structural reforms can wait.

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Summary

After the landslide victory for Mr Modi some pundits argue that he should take on bold structural reforms. We do not agree. Rather than taking on risky and time-consuming reforms, Mr Modi first needs to help India regain growth momentum through expansive fiscal policy and easier monetary policy. The Indian economy has suffered two successive years of subdued growth. On the very first day of the government taking over, growth data showed a 5-year low of 6.8% for FY2019. The unemployment data confirmed severe joblessness in the economy. While we don’t deny the importance of structural reforms in areas such as land and labor laws, Mr Modi should first focus on reviving the economy so that it can swallow painful reforms later.

A decisive mandate for the right wing in 2019

Results from India’s general elections in 2019 showed a massive victory for the Bhartiya Janata Party and its allies known as National Democratic Alliance (NDA). The party increased its seat share to 303 in 2019 from 282 in 2018. The NDA’s (BJP, Shiv Sena, Janata Dal (United) among others) vote share in 2019 stood at 45% much higher than 38% garnered in 2014. The performance of NDA in states such as West Bengal, Odisha, Tripura and to some extent in Telangana, improved in terms of the number of seats won.

 
 

Segments of the economy that are powering down

During the last two years of Modi 1.0 the domestic economy witnessed subdued growth. The growth in FY2019 hit a 5-year low of 6.8% YoY. The growth in agricultural sector declined to 2.9% YoY in FY2019 from 5% which implies distress in the farm sector. 

The second half of FY2019 also saw a consistent deterioration in industrial production (IIP) due to sub-par performance in manufacturing sector. The capital goods sector reflecting investment level in the economy has been on a declining trend since October 2018.

More recently, private consumption are starting to exhibit a subdued growth due to the liquidity issue that emerged in non-banking financial companies (NBFC) crisis in H2 FY2019. The lack of credit leading to slowing growth in both consumer durables and non-durables.

The periodic labor force survey report also confirmed that India’s unemployment rate for 2017-18 is at the highest level of 6.1% in 45-years. Accelerating growth will mean addressing each of these issues urgently.

The economy needs a mix of fiscal and monetary easing.

Some pandits are calling for Mr Modi to use the political capital he gained from the landslide victory to implement painful structural reforms. We do not agree. In our view instead the focus of Modi 2.0 in the near term should be to use both fiscal and monetary policies to stimulate the economy. Since we have a tolerable level of inflation (7-year low of 3.4% in FY2019), a muted industrial output and low private investment calls for a policy rate cut.

The fiscal spending was somewhat in FY2019 on account of lower revenue collection. The growth in net tax collection on products declined to 8.8% YoY in FY2019 from 9.8% YoY in FY2018. Instead of rigidly sticking to a fiscal deficit rule, the government should give a higher push to infrastructure and social capital creation.
A mix of both fiscal and monetary measures is the need of the hour to address the slowdown in the short to medium term. In the long run, structural changes such as agricultural policy, reforms in land and labor laws and privatization of sick public sector undertakings can also stimulate economic activities.

Conclusion 

Given India’s subdued growth, the government should focus on expansionary policy measures in the near term rather than bringing in about more structural reforms. Provided India’s inflation remains within RBI’s target and with a strong rupee, Modi government can afford bold monetary and fiscal profligacy.