Modi's biggest test is to get economy going

Low inflation and low food prices is not always good news for any economy-watcher. Compare the record low retail inflation of 2.18 per cent for May with the Index for Industrial Production (IIP) of 3.1 per cent for the same month, which was announced on Monday evening. It points to an anaemic economy which is unable to produce more and spend more. The farmers are sure to complain that low prices for pulses and vegetables, which is seen as the main reason for low inflation, is bad for them because they do not get the right price — that is they do not get back the money they have spent in producing pulses and vegetables. If the market price is less than what they spent then it is deathly loss for them. We can ignore farmers’ complaints as we do when the oil-producing countries are not too happy when crude oil prices go down, but consumers are happy and it is reflected in greater consumption of petrol and diesel and the sale/purchase of cars. It is quite clear that low inflation and low food prices has not increased the consumption pattern. That is what seems to underlie the low IIP figure. Demand is subdued, and that is really a euphemism. Low consumption is injurious to a market economy. It might appear to be an ideal state for a Buddhist economy as low consumption can be termed a state of economic nirvana. Socialists and other sundry leftists tend to lean towards this austere state. But in a normal economy decline in consumption means the economy is declining.

The chant that low inflation means that the monster of inflation is under control and that the Monetary Policy Committee (MPC) of the RBI must stop playing spoilsport and cut interest rates at the next meeting seems nothing but immature. There is no proof that high interest rates are inhibiting expenditure. Even former RBI governor Raghuram Rajan used to argue that it is not true that interest rates are holding back consumption. It is weak demand that is the culprit. It is necessary then for policymakers and decision-makers in the government and outside to look beyond inflation, and look at what is holding back the economy. What seems to be lurking on the horizon is the spectre of deflation, a deadly phenomenon for any economy. It might seem that it is difficult to choose between the evils of very low inflation on the one hand, and soaring inflation on the other. Economists are willing to admit that a higher inflation within a band is preferable because it would mean that the economy is moving and sputtering. A very low inflation of the 2.18 per cent variety is not something that is to be greeted with a loud hurrah. Combined with low productivity, low inflation is a symptom of an ailing economy.

This is a clear challenge for the BJP-led NDA government of Prime Minister Narendra Modi. The Prime Minister and his colleagues in the government and in the party had been crying out from the rooftops that they had brought the economy out of the slough of five years of UPA-II, and that they have infused irrepressible optimism and confidence into it. The sad fact is that the economy has not taken wing as it was expected to do. Mr Modi’s critics and detractors may want to blame his government for the failure to spur growth. In the first two years, the BJP had an alibi. They could blame the bad economy that they had inherited from Prime Minister Manmohan Singh and his scandal-scarred government. But in the third year, blaming the predecessor does not make sense. Team Modi can claim they have taken two major decisions that will significantly impact the economy. First is the November 8, 2016 demonetisation through which Rs 1,000 and '500 notes were taken out of circulation. The intention was to check black money as well as excessive cash, which seemed to flood the circulatory system.

Whatever may have been the intention, it seemed to have jolted the economy, specially the informal sector, which operated exclusively through cash, and brought it to an ominous halt. The analysts are now saying that it is the cash crunch that has brought down food prices, apart from higher production. Demonetisation, whatever may be the good it is supposed to do in the long term, has proved to be painful, and even disastrous, in the short run. The other big decision which the government takes pride in is the rolling out of the Goods and Services Tax, the single pan-Indian tax system, from July 1 — which is supposed to bring down tax rates, improve tax compliance which means that the government — at the Centre and in states — will have more money to spend on physical and social infrastructure, and it is assumed that this would also encourage people to produce more, sell more and buy more. The economic engines are expected to fire on all cylinders. There is apprehension, however, that the GST, considered to be an enlightened system for some mystical reason, will not bring the beatitude that it promises immediately. It is admitted even by its ardent promoters that the GST would be accompanied by hiccups in the beginning and this could last for a year before the system gets going.

Again, in the short term, the GST is going to be a speedbreaker rather than a stimulus. While a rational tax system has a tonic effect on an economy that is running smoothly, it may not energise an economy which seems to be going nowhere. Low inflation and the low rate of growth in manufacturing, combined with the aftereffects of demonetisation and the introduction of GST, could aggravate the situation before it gets better, if it gets better at all. The bleak truth is that people do not have enough and more money to spend, which is the way to push the economy up. The Modi government cannot any more wrap itself in sloganeering and fluffy initiatives like Make in India, Skill India, Digital India, et al.
There is no activity on the ground. The economy needs a push. Pep talk will not do the trick.