HOW IS INDIA DOING?

1. Introduction:

        With the Russia-Ukraine war now in its 11^th week, and with some people even saying that it might lead to a global war, many questions are being raised, including: how is India doing?  How is the war likely to impact the Indian economy?  What are the likely risks?  The objective of this piece is to attempt to answer these questions.

2. How is India doing?

        Let me attempt to answer this extremely important question by focusing on four parameters: GDP growth, the employment picture, public finances, and the balance of payments.

2.1 GDP Growth:

        The war and the sanctions have caused major disruptions in the supply of many commodities and have broken the supply chains of many commodities, with these disruptions and breaks causing prices of the concerned commodities to rise.  Crude oil is one such commodity.  With as much as 85% of India’s crude oil requirements met through imports, this will certainly adversely impact our current account deficit and therefore GDP.  On the other hand, the war has positively impacted our foodgrain exports.  Further, there are some press reports, suggesting that India needs to substantially improve its war preparedness.  This may have the effect of substantially increasing our imports.  Exports in April this year are reported to have gone up to $38 billion, but imports have gone up to $58 billion, thus widening the trade deficit to $20 billion.  Let’s wait for some time and see what happens to India’s numbers on trade deficit and current account deficit, but it appears that the war’s impact on India’s GDP will not be insignificant. 

        The Reserve Bank of India has projected a GDP growth of 7.2% for 2022-23 in its Monetary Policy Statement of last month.  Let’s see what happens to this projection.  But I must say while a GDP growth of 7.2% is a respectable rate of growth, it must be, given India’s requirements, much higher, and for several years in a row.

2.2 Employment Picture

        The employment picture in India, although somewhat better now, continues to be a cause for serious concern.  According to some press reports, there has been a decline in labour force, suggesting that many unemployed people have lost all hopes of getting gainful employment and therefore have stopped looking for work.

Why is the employment situation so bad?

        One major reason is the persistent decline in the elasticity of employment to growth.  This is how the Centre for Sustainable Employment at Azim Premji University has described the situation: “Even as GDP growth rates have risen, the relationship between growth and employment generation has become weaker over time. In the 1970s and 1980s, when GDP growth was around 3-4 per cent, employment growth was around 2 per cent per annum. Since the 1990s, and particularly in the 2000s, GDP growth has accelerated to 7 per cent but employment growth has slowed to 1 per cent or even less. The ratio of employment growth to GDP growth is now less than 0.1.” 

        Why has the elasticity of employment to GDP growth declined so sharply?  I did some work in this area a long time ago and this is what I wrote, then:  “A striking feature of the trends in tax incidence and labour intensity is that while the average labour intensity of the private corporate sector in India has declined, industries with labour intensity lower than the average for all industries have enjoyed considerably larger relief in tax incidence than industries with labour intensity higher than the average for all industries.  Total reduction in tax incidence of industries with lower-than-average labour intensity (e.g., aluminium, cement, and electricity generation and supply) works out to 3.59 times the reduction in tax incidence relevant to industries with higher-than-average labour intensity (e.g., coal mining, cotton textiles, and jute textiles).  Clearly, the way corporation tax policy has operated in India, it has tended to induce distortions which have favoured the employment of capital, with the result that the labour intensity of industrial output has suffered a decline.”

        There is reason to believe that the corporation tax policy continues to induce distortions which favour the employment of capital.  Our labour laws and technological innovations (e.g., robots) have also contributed to the decline in the elasticity of employment to GDP growth. 

        The increase in income and wealth equality in India has also contributed to the decline in the elasticity of employment to GDP growth, given that the consumption of the rich is less labour intensive (and more import intensive) than that of the poor.

2.3 Public Finances

        India’s public finances are not in a good shape.  One reason for this is a major distortion on the expenditure side.  Rather than focusing on public goods (e.g., national defence, control of pollution, elimination of open defecation, law and order, and delivery of justice), our policymakers are focusing on subsidies and welfare spending. Pradhan Mantri KIsan Samman Nidhi (PM-KISAN) is a good example.  Under this programme, farmersare provided direct income support at the rate of Rs. 6,000 per year.  The Government of India’s budget for 2022-23 has allocated as much as Rs. 68,000 crore for this programme.  With the Central Government spending such large amounts of public money for the welfare of farmers, an important votebank, the State Governments do not want to be left behind.  So, they also resort to such spending.  Look at what the Government of Punjab has done.

        Another major reason for India’s public finances not being in a good shape is the inefficiency in the implementation of projects involving huge spending of public money. The Ministry of Statistics and Programme Implementation’s recent (December 2021) update covers 1,679 projects, each costing Rs 150 crore or more in 10 areas (including roads, railways, power, petroleum, urban development, coal, water, atomic energy, steel and telecommunication). Of these, 11 projects are ahead of schedule, 292 projects are on schedule, 541 projects are delayed and then there are as many as 835 projects for which neither the year of commissioning nor the expected date of completion is available!

        The total original cost of implementation of these 1,679 projects was Rs 22.3 lakh crore, but now their anticipated cost is around Rs 26.68 lakh crore.  Which means, one may say, a cost overrun of as much as Rs 4.38 lakh crore.  But this is too narrow a way of computing the cost of inefficiency in project implementation.  One must add to this figure of Rs. 4.38 lakh crore the monetary value of the benefits that would have accrued to India had the projects in question been completed on time, to arrive at the total cost of inefficiencies in project implementation.

     The final reason for India’s public finances not being in a good shape lies in our huge fiscal deficits.  The Government of India alone has budgeted a fiscal deficit of Rs. 16.61 lakh crore (6.4% of GDP) for 2022-23.  The data on the State Governments’ fiscal deficit for 2022-23 are not available, but it can be estimated at, say, 3.5% of GDP.  All this adds to India’s huge government debt.

2.4 Balance of Payments 

        With foreign exchange reserves of about $600 billion, India’s balance of payments situation today is substantially better than that in the summer of 1991, when our foreign exchange reserves fell to a mere $0.6 billion and we had to airlift huge quantity of gold to pledge it against a borrowing of, if I remember correctly, $400 million.  But we should not forget those nightmarish days as we have not built these reserves through current account surpluses. We have built these reserves out of capital inflows through foreign direct investment, foreign portfolio investment, non-resident Indians’ deposits, external commercial borrowings and so on. Our external debt amounts to about $615 billion and we still have current account deficits.

        We need to serve the external debt that we have piled up.  We also need to serve the portfolio of foreign direct investment that we have built up, through remittance of dividends and of the principal value in case a foreign investor exits India.

3. What are the likely risks? 

        At least two risks.  One, our government debt is already about 90% of our GDP.  It seems we will have to spend much more to strengthen our defence preparedness.  And with the Reserve Bank of India having raised the repo rateby 40 basis points to 4.4%, interest rates will go up.  These developments will have the effect of increasing our fiscal deficit and thereby our government debt.  At some point, it may become unsustainable.

        And two, oil prices may go up still higher and that may have the effect of widening our current account deficit.  Of course, our foreign exchange reserves are at a very comfortable level and we can use them to finance our current account deficits.  But as I said, we have built our foreign exchange reserves out of capital inflows through foreign direct investment, foreign portfolio investment, non-resident Indians’ deposits, external commercial borrowings and so on, and therefore we have to bear in mind that these reserves, depending on the investors’ risk perceptions, may start drying up and, as a consequence, it may become difficult for us to keep on financing our current account deficits.

 - Anand P Gupta, Former Professor of Economics, Indian Institute of Management, Ahmedabad