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2022 | Book

Macroeconomic Policy in India Since the Global Financial Crisis

Trends, Policies and Challenges in Economic Revival Post-Covid

Author: Dr. Sebastian Morris

Publisher: Springer Nature Singapore

Book Series : India Studies in Business and Economics


About this book

This book discusses the Indian economic crisis and brings out what went wrong and the correction necessary for getting the economy back to high growth trajectory, leading to economic transformation. To do so, the book covers trends in performance of Indian economy since the Global Financial Crisis to the COVID-19 effect, bringing out factors that have determined the same.

The book questions the approach to macroeconomic policy of both the RBI and the government and brings out what it takes for macroeconomic policy to be supportive of high growth. It contains revealing contrasts with East Asia and China, although India has the same potential to grow with an expansion of manufacturing. Overall, it argues that macroeconomic policies (as much as structural, industrial, and trade policies) have been deficient and even good initiatives on the industrial policy and trade flounder for the lack of a strategic approach to macroeconomics. The book highlights the special opportunities present in an emerging economy with vast under and utilised labour and the macroeconomic policy initiatives that can take advantage of this key feature.

It covers the macroeconomic data on growth using multiple indicators, then the external shocks and the internal policy measures/responses; besides, GVA/GDP, credit, exports, external transactions, interest and policy rates, yields, exchange rates, money, capital flows, indices of industrial sector, price indices and inflation, government expenditures, tax rates, fiscal deficits, market uncertainty measures to present a holistic picture of the economy and the shocks and policy actions that have followed. The book uses an innovative method of presentation and the consistency of the trends/stances of both monetary and fiscal policy using these large number of variables. It discusses the debate on overestimation of GDP/GVA growth estimates over the years from 2011-12 to about 2016-17 comprehensively. There is special coverage of GST with a comparison with China. Coverage also includes performance since the COVID-19 crisis again using a large number of indicators and an explanation for the same in terms of the limitations of the government’s initiatives to counteract.

The book is a quick and ready reference of what has happened in macroeconomic terms to those interested in the relevant facts. It is of interest to international economists, policy analysts, and investors whose need to understand that the Indian economy in macroeconomic terms and in terms of the stances and penchant of the government and the RBI is of value.

Table of Contents

Chapter 1. Introduction
In this book, we bring out the performance of the Indian economy, and review the approach of macroeconomic policy especially demand management in the Indian economy, since the Global Financial Crisis. We also consider the COVID crisis and its impact, and the measures adopted to mitigate its effects by both the government and the central bank focusing on the macroeconomic dimensions of the various initiatives. We also cover the issues related to manufacturing performance in India. At end of November 2021, the economy showed a mixed response with the stock market rising sharply though the recovery was modest, and as on date is yet to go decisively over the levels reached in 2019 a year before the crisis.
There is much hope though that the capital investments cycle which had been depressed almost since 2012–13 would revive based on the government’s initiatives in manufacturing, and due to the positive effects (for India) from the vastly changed global economic environment, especially those related to China, and its relationship with Europe and US, especially the latter. The institution of GST has created disincentives against investment support on the part of regional governments, and the institutional mechanism also makes it difficult to quickly use tax cuts as countercyclical policy and puts an upward political bias to keep rates high.
We also lay out an enhanced macroeconomic framework that recognizes shocks that heighten uncertainty increasing the portfolio demand for money, as the role of “structural” policies on the capacity (full employment) output in macroeconomic management. We bring out the limitations in the CPI that is used by policymakers including in the core CPI. We also take into account the correction required in the new GDP11-12 series which had in the early years overestimated the growth in the Indian economy.
This chapter covers the conceptual enhancements to the standard macroeconomic framework and also provides a synopsis of the coverage and results brought in other chapters of the book.
Sebastian Morris
Chapter 2. Trends in Growth Since the GFC
In this chapter, we being out the estimates of growth from the period since the Global Financial Crisis (GFC) using a variety of data—GDP using both the series with 2004–05 as base year and the new series with 2011–12 as base year, besides the Index of Industrial Production (IIP) as well again with both base year. What should have been a simple matter is made difficult by the divergence in the estimates of growth between the two national income series, by as much as 1.5% per annum over the years that they overlap. The problem of overestimation is recognized, the trends in growth are drawn by considering the physical IIP. Growth had been high at around 9% for the 2 years following the GFC when the fiscal stimulus was in place. Thereafter it fell and rose again briefly in 2016–17 to fall again. From late 2018 growth slowed down to reach a low level of just a wee bit above 4%. The manufacturing, and the trade, transport, storage, and communication sectors too show trends which are broadly similar, and the low growth from 2011 to 2012 onwards is supported by the lower rate of gross capital formation in India.
Sebastian Morris
Chapter 3. Credit, Employment, and the Current Account
In this chapter, we bring out the trends in credit until the eve of the COVID crisis. Credit growth has been muted from around 2016, being close to zero or negative for industry reflecting not only the slow down but the problem of non-performing assets (NPA) and high risks both perceived and real in lending to the industrial sectors. Credit growth to the services sector was higher but still below 10% generally and much lower than in the earlier period. In all sectors, credit growth declined sharply from 2019. Since there are significant changes in the labor participation rates, the growth rate in employment when considered presents a dismal picture right from 2016 of little or no growth in urban employment and marginal growth in rural. Goods exports remained nearly stagnant over the period, and services exports grew from 2017 but both fell off from 2019. The current account deficit was low implying a low growth of the economy. The “Tiger Period” from 2003 to 2004 to the Global Financial Crisis (GFC) saw very rapid growth in net portfolio investment and in FDI.
Sebastian Morris
Chapter 4. Capital Formation and Foreign Investment
In this chapter, we bring out the trends in gross capital formation, and in foreign investment both FDI and FII. Gross capital formation has been muted its share falling from the high levels achieved in the “Tiger Period” to levels around 32%. And the share of the private sector had fallen from the high levels reached. The story of reforms since 1991–92 has been one of the shares of private corporate sector rising. Both portfolio and direct investments have been modest or nearly stagnant though showing much volatility. FDI has generally followed growth. In the period since 2011–12, they mirror the overall slowdown and the fall in the rate of gross capital formation.
Sebastian Morris
Chapter 5. Inflation and Monetary Developments
In this chapter, the trends in inflation are brought out and corrections made to the same since the CPI has major issues. We discuss the problems with the CPI, that even the core measure is erroneous, because of the treatment of rent expenditure by recourse to the government and public sector employees’ House Rent Allowance (HRA) as part of the rent payments. The weight for food being overly highin the Consumer Expenditure Surveys of the National Sample Survey. With the corrections, the inflation in recent times have been modest at around 5% of lower, and had steadily declined from 2011 to 2012 onwards. The mistaken reading of “high inflation” in 2010–11 may have been the basis for the rather steep monetary tightening that the RBI had put in place 2011–12. Furthermore, the rates of interest may have been higher than that indicated by the policy rates—repo and reverse repo—since the low-end bond yields were often well above the repo implying an unstated credit rationing indulged by the RBI. Rates had been coming down from the very high rates reached during the “taper tantrum” but rose again from 2017 and began to decline from 2018. Uncertainty in the financial market rose sharply from 2019 onwards.
Sebastian Morris
Chapter 6. Policy and Analyses
Here, we bring out the key influences, both shocks and policy changes, that account for the performance of the economy brought out in the earlier chapters. Being an analysis of the dynamics of the short run, the focus is on demand and its determinants. Structural policies and changes are covered to the extent that they have a bearing on the demand. We cover both the financial market side (including the global market) and the goods and services market. The emphasis is on the policy though since the Indian economy being small in relation to the rest of the world, there is always a policy response that is possible to keep growth at high rates, given also its emerging character—the availability of idle and underutilized labor. The fiscal stimulus provided to counteract the GFC was what kept growth rates at a high level of 9% in 2008–09 and 2009–10 and part of 2010–11. The near simultaneous withdrawal of the fiscal stimulus and the monetary contraction (to fight largely a supply-side inflation that was also overestimated), c.2011–12 was the immediate reason for the sharp decline in investment and in output. The problems were compounded by the so-called “policy paralysis” brought about by a spate of bans and governance issues in the telecom and mining sectors. However, the suddenness of the monetary squeeze when the rest of the world was still in a situation of ample liquidity braked investments generally and brought many of the investment projects in infrastructure including PPPs to their knees. Many had built in debilities but not all. The feedback effect from problematic design to a high interest rate regime put pressure on the banking system to which the risks had been shifted. The uncompensated demand reduction due to the success of the GST was an issue. Most initiatives of the Modi Government, despite their potentially very large public and social value, did not have the necessary basis in design, organization, policy and law, and as such had little impact. The fiscal side too was conservative with the large reduction in the MGNREGS allocations, and the underspending vis-à-vis budgets in a period when “animal spirits” were down.
Sebastian Morris
Chapter 7. Reflexive, Not Reflective Monetary Policy
In this chapter, we re-examine the approach of monetary policy in India, including the stated objective of “fighting” inflation.
Sebastian Morris
Chapter 8. The COVID Crisis and Response
In this chapter, we write about the COVID Crisis as it unfolded, without the benefit of hindsight. The data and the analysis are therefore of meaning when considered with reference to what was known by early May 2020. The situation prior to the COVID as brought out in the Chaps. 27 was problematic with major slowdown and heightened uncertainty in the financial sector in the last year before the crisis. The crisis changed everything. The now steep fall “due to the crisis” could now confound the earlier slowdown. If every country was expected to decline by around 20–30% over the immediate quarter then a decline of the nearly the same order but from a prior slow growth should not have attracted attention on the ground that there had been a slowdown. The response of the RBI, free from its conservative shackles, now followed the US into expanding liquidity and supporting the financial sector, in ways that were quite radical for the RBI. In contrast during the GFC the RBI had to be persuaded to act. There were no arguments against the need to adopt supportive and expansionary monetary measures, and the governor with no doctrinaire blinkers could address the reality. However, the government in its fiscal response was barely adequate. The “20 lakh crore” stimulus was misleading. Only about Rs. 1.72 lakh crore involved expenditures directly or indirectly by raising consumer incomes. The rest were liquidity, credit, and guarantee measures, and included a borrowing limit enhancement for the state governments. The response was in sharp contrast to the response to the GFC when the central government took the leadership role to put together a fiscal package and persuade the RBI to expand liquidity, to restore the growth to almost its original level. The administrative measures of territorial lockdowns did little to contain the spread, but imposed great hardship on the people, especially the migrant workers, besides curtailing production wantonly. We estimate the unconditional impact of the crisis (i.e., without the fiscal response) should have taken the economy down from its 2019 to 20 value to between 8.86 and 12.23%, and conditional on the stimulus to a value of −6.21 to −9.68%, most likely closer to the latter. The very early estimates were somewhat worse, but the RBI in responding swiftly and in kind ensured that there would not be a monetary constraint, and hence a simpler expenditure model could be used.
Sebastian Morris
Chapter 9. The Recovery
In this chapter we bring out the performance of the economy over the crisis period and its subsequent recovery. Since the decline over the initial quarter of the COVID crisis was steep being in the range of 20–30%, growth over subsequent quarters or months in relation to the very low levels appear high. To overcome this “base effect” which would affect normal YoY estimates of the growth, we have variously used rolling moving averages and current month or quarter over previous pre-COVID month or quarter. In this chapter we bring out the performance of the economy over the crisis period and its subsequent recovery. We consider first the performance of the stock market which is seemingly out of line with the performance of the economy. We explain that there is no anomaly here, since h the discount rates (both foreign and domestic) had fallen considerably owing to the fall in the interest rates over various maturities. Additionally, costs such as interest, and tax (corporate) besides labor had fallen. The effect of the crisis was quite severe on the manufacturing sector, and not all segments have recovered. Capital goods and durables have yet to reach their pre-COVID levels. Employment recovery has been most problematic. We bring out the trends in employment, credit, portfolio, and direct investments, and also review the monetary developments. Employment recovery has been particularly problematic and there are large employment losses in the manufacturing sector, and recovery in employment is well below the pre-COVID levels. It is unlikely that without the revival of the investment cycle there would be job creation. A significant part of the job losses in the manufacturing sector seems to be “structural”. We consider in detail the effects of the initiatives of the RBI on the financial sector and show that the RBI was able to bring down the low end rates quite sharply and marginally the 10-year bond yields, so that the uncertainties with regard to the future rates continue. This is a doubt due to the continuing belief of the capital market that the RBI would respond to CPI inflation given its stated target of inflation (CPI rather than Core CPI) targeting. We conclude that the recovery has barely taken the economy back to the pre-COVID levels. And employment recovery in industry and manufacturing has yet to take place. There have been massive job losses which are in part being hidden by the return to agriculture (with its disguised employment) and fall in the labor force participation rates.
Sebastian Morris
Chapter 10. The Challenge of Manufacturing
In this chapter we analyze the reasons for the modest performance of Indian manufacturing despite its potential. In the analyses the contrast is with the East Asian “Tigers” and China, which all adopted Export Led Growth (ELG)”. In the process we characterize ELG as the simultaneous pursuit of both import substitution and export promotion and not the movement to laissez-faire as many assume it to be. ELG has its own macroeconomic aspect—undervalued currencies, low interest rates, and a growth rather than inflation orientation. The fact of idle labor in transforming economies makes it imperative to reconsider some of the tenets of both conventional trade theories and macroeconomics. We also bring out industrial and trade policy-related debilities on much of manufacturing—tariff inversions, excessive taxation. These had kept scales low and costs high. The prices of non-tradables especially infrastructure services and goods have been very high as well. For long years the export trade profitability was lower than the domestic trade profitability. More functional tariffs allowed the automobile sector to perform better. We also bring out how the vast demand potential in electronics, solar panels, computers, mobiles have been missed by crucial errors of policy. Similarly, we also bring out the perverse consequences of large positive deviation from the uncovered parity condition which not only increases the cost of capital for Indian businesses but puts them at a disadvantage vis-à-vis MNCs, which situation had been avoided by the East Asian “Tigers”. We list out the recent initiatives of the government, especially the Production Linked Incentive (PLI) scheme. The scheme we believe (though too early to analyze) could affect positively certain sectors. The changing global environment brought about by China being seen as an adversary by many countries including the US, China going “green” and China consciously moving into high-tech industries could act in conjunction with the PLI. The very success of ITES and the large remittances inflow act  to create a “Dutch Disease” on manufacturing.
Sebastian Morris, Kapil Shukla
Chapter 11. GST and the Discrimination Against Production Oriented States
Goods and Services Tax as introduced in India, being a destination oriented tax, does not encourage regions to promote manufacturing and tradable services industries. The country is at an early stage of its economic transition, and the states have a subnational character. It is important that the states engage in locational tournaments to attract investments by providing infrastructure services, governance, and other public services. We develop a new consumption-based approach that adjusts the detailed consumer expenditure figures of the National Sample Surveys at the state level to estimate the Revenue Neutral Rates at the state level. There are stark differences between the rates for the producing states and the consumption-oriented states amounting to as much as 20% of GDP. The divergence is higher than those arrived at by the Government before the introduction of GST. The proposed compensation scheme that protects revenue at 14% growth for 5 years would be unfair to the producing states once the 5 years are over. As GST impacts the locational choices of new investments, the lack of fiscal incentives for states to attract and nurture investments, unless corrected, would have deleterious effects. A significant share of the Centre’s collection of GST may have to be distributed based on manufacturing and tradable services production, if the country is not to lose the steam of high and growing investments to take it through its economic transformation. The institutional mechanism for GST, viz., the GST Council in its present form would make it difficult to quickly cut or raise tax rates including across the board changes that are necessary for macroeconomic management.
Sebastian Morris, Astha Agarwalla, Ajay Pandey, Sobhesh Agarwalla
Chapter 12. Conclusions
The Global Financial Crisis (GFC) did not lead to a reduction in growth in India. Growth, which had reached a level of 9.75% in certain quarters, before the crisis, had marginally slowed down over the last three quarters before the GFC, due to the restrictive monetary policies pursued by the RBI, to quell a supply side inflation a part of which was imported through higher oil prices. Growth nevertheless was at around 8.5% on the eve of the crisis. The RBI during the early part of the crisis delayed its response. However the government had its fiscal counter action ready and as a result growth did not really fall for the next two years being supported at nearly 9%. However, the RBI seeing high inflation (largely because the CPI was being erroneously computed),  acted to dramatically raise interest rates, which brought investments down by nearly 4% points as a share of GDP.  This happened when the fiscal stimulus was being withdrawn. Almost until 2018, the RBI kept a hawkish stance. Other actions such as underspending in relation to budgets (which happened during the first two budgets of Modi-I),  the early bans by the courts of important activities, the nearly unconditional pursuit of the fiscal deficit targets, significant pull back in MGNREGS spending, demonetization, unwarranted uncertainties imposed on an important industry -automobiles- further contributed to what was to become the longest period of slow growth since the Great Liberalization of the early 90s. Over a significant part of this period the policy rates underestimate the interest rates since the repo window was not open wide.  The financial sector too was under stress due inter alia to the slowdown itself, the delayed response of the government to shore up the net worth of PSU BFSIs (and hence of the pressure on NBFCs),  the poor lending practices especially to the infrastructure sector, and to the tightness in credit.  GST in improving the tax compliance raised the effective tax rate to put further pressure on demand. In the run up to the 2019 elections, which was also when global economies showed a spurt up, there seemed to revival, which however proved to be ephemeral since the growth on the eve of the crisis was most certainly no more than 4.5%.  The COVID Crisis brought about a decline which was much larger than it need have been, due largely to the dysfunctional lockdowns over the first six months of the crisis.  The response of the government in expenditure terms was modest with an additional thrust of just about 1.6% of GDP.  The RBI however responded very well, and its response overcame the problems with the financial sector seen before the COVID crisis.  Recovery has been modest, and even as late as 2021(Q4) output had barely crossed the level before the Crisis. Gross Capital Formation rates which had fallen to 30% or lower in 2012-13 from the high 36% in the "Tiger" period from 2003-04 to 2007-08, continues at that level or lower.  Private investment has been the casualty.  The recovery as expected varied much across the sectors. Employment in manufacturing  is nowhere near the pre-COVID level.  The experience of macroeconomic management reveals that the key to high growth is the positive combination of macroeconomic measures with "structural reform" measures, which was missing during much of this period. The movement to Direct Benefit Transfers, though the design could have been much better was positive, but little else of the many announced initiatives during both Modi-I and II were systematically pursued.  Poor design and organizational limitations of the government ensured little more than launches.  The relatively poor performance of manufacturing  in India is constrained by macroeconomic and trade  policies, that are not conducive. The contrast with the East Asian Strategy of export led growth is large. Recent initiative in the form of the Production Linked Incentive (PLI) scheme has potential, especially now that there are three China related factors (going Green, emergence as an adversary to the western world, and its own leadership not refraining from bans to achieve green goals) that could help some of the manufacturing sectors.  We also argue that macroeconomic management for emerging economies with vast unutilized (but ready to be used) labor has to be very different from the standard approach that works  for the advanced countries and others where such is not the case.  In this chapter only the main conclusions are stated. The current high inflation is argued to be supply side inflation of a new kind that is best termed as a 'logistic' inflation.  
Sebastian Morris
Macroeconomic Policy in India Since the Global Financial Crisis
Dr. Sebastian Morris
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Springer Nature Singapore
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