It is nearly two weeks since I wrote the piece titled, ‘Raghuram Rajan has the last laugh’. I cannot believe it is almost two weeks!
In that post, I had mentioned what the Government of India needed to do:
It has pursued a policy of targeting tax dodgers and other wrongdoers in the business community. Nothing wrong here. I am not even going into the question of whether the government had been selective or unbiased in these pursuits. It has done well to do this for it is never the case of this blogger that India’s private sector is an epitome of business ethics and virtues. Far from it. India’s economy or capitalism always was in peril and is in peril from India’s capitalists with very few honourable exceptions. So, the pursuit was fine.
But, the government should have realised that it would have an impact on sentiment and on investment by businesses. It must have had a Plan B already. [Link]
But, this was not the Plan B I had in mind. The Government of India is setting up an anti-profiteering authority to ensure that the tax credits accruing to businesses under the new ‘Goods and Services Tax’ (GST) is passed on to consumers and that there is no profiteering. Perhaps, the government is paranoid about the inflation impact and hence, of the Reserve Bank of India’s tight money policy. It desperately wants low interest rates. Or, it is really worried about popular backlash that could arise if profiteering were rampant. More likely both. Alas, the road to hell is paved with good intentions.
This morning, I read my friend Niranjan’s piece in MINT on Money Illusion. I think, if I understood him well, his point is that the public are used to high inflation rates and expect their nominal earnings to rise at a certain rate based on their own estimates of what the inflation is. Since prices are rising far slower, probably, incomes and earnings of certain categories of the society – small businesses, wage-earners, may be? – are rising far too slowly. Naturally, they feel unhappy about it. Hence, they may be holding back their spending, etc.
Although the real growth rate is around 7%, the nominal growth rate is lower – around 10% to 11%. But, society is used to nominal growth rate of around 15% and the concomitant growth in many nominal quantities. That is not materialising and hence, they feel that growth is suffering. That is money illusion. This can also become a vicious circle. Or, it probably, has already.
As hypotheses go, this is not a bad one.
But, I have some reservations on Niranjan’s hypothesis:
(1) The 7% growth rate that is reported under the new methodology and new base year 2011-12 may not be the same as the 7% in the old methodology with the old base year, 2004-05. In other words, we do not have a benchmark. Under the new methodology, the potential growth rate of the economy may be 10% or 12%. Who knows? May be, that is a reason, the inflation rate is declining. NO, scratch that. I have a better hypothesis that follows.
(2) Some nominal quantities such as credit growth are really low, even after one adjusts for lower nominal GDP growth and also for the fact that electricity boards may not be borrowing as much as they used to from banks as before, after UDAY (debt restructuring for State Electricity Boards). Further, many FCNR (B) loans taken by Indian businesses are being unwound now.
Notwithstanding these special factors, it is difficult to argue that credit growth numbers are better than they really are. They do indicate both absence of demand for credit from potential borrowers and banks’ capacity to supply credit.
(3) The implicit assumption he is making is that the Indian economy is indeed growing at 7% real and it is the absence of inflation that makes us feel that there is no growth, because we are used to thinking in nominal terms. Actually, I question the premise that we we are indeed growing at 7%. I very much doubt that.
If we drop the pretense that we are growing at 7% or thereabouts, then there is no money illusion to speak of. The angst is real.
I think one of the reasons – it, too is a hypothesis – that India’s inflation rate is declining – and it does not preclude economic explanations – is that economic uncertainty has increased relentlessly in the last one year +. It is still rising and that it has dampened economic activity and hence, weakened aggregate demand except for personal spending to a limited extent. Hence, there is no inflation impulse. Yes, yes, I am aware that, in India, food items has a weight of 45% in India’s consumer price index (CPI) and that the prices of agricultural produce have been declining. In fact, even Wholesale Price Index (WPI) inflation is low and the weight of food in that is not this high. It is more weighted towards manufacturing. So, my hypothesis is highly plausible.
Why do I say that uncertainty has been rising relentlessly? India’s tax terrorism has been relentless – many tax circulars and notifications have been issued and then withdrawn or clarified (The SARAL form was changed to include declaration on assets and then withdrawn and taxation of mutual fund transactions in third-country locations was announced and clarified and amended later). There has been badly designed tax amnesty schemes. There has been the pursuit of black money. Retrospective taxation remains in the statutes.
Now, there is an anti-profiteering authority. It is not possible to arrive at a mechanical or mechanistic interpretation of profiteering. But, that risk now exists. Going by past record, that risk is non-trivial.
Then, there was the pursuit of non-performing assets guided by the Reserve Bank of India, under the previous governor. In any case, loan growth had slowed under the weight of bad assets in the books of banks and under the weight of high liabilities in borrowers’ balance sheets.
There has been the note-ban exercise which created its own uncertainties, besides acting as barriers to transactions in rural commerce, in agriculture. The All India Manufacturers’ Organisation (AIMO) had done surveys that found extensive impact on rural employment. Now, AIMO has actually sought a postponement of GST. Unlikely to be conceded.
The real estate sector, awash with black money, has been hit by the note ban. Then, they have had the Real Estate Regulation Bill. Anecdotal evidence suggests that real estate sector activity has considerably slowed. It showed up in the national income statistics for the fourth quarter of 2016-17. I do not think it is over yet. Probably, it is just beginning. Then, there has been the benami transactions bill. There is a new bankruptcy code and, may be, the mother of all uncertainties, GST. Hope not.
The icing on the cake is the anti-profiteering authority. The more the government wants to curb and check and prevent profiteering, the more it is going to strike at the roots of economic activity. It is failing to follow the 80-20 principle or management by exception.
Some or many or most of these government measures, legislative proposals may be good for the long-term while some may offer mixed benefits. But, they are inevitably short-term negative for economic activity. They are essential surgeries, may be. But, painkillers are needed during and after surgery. Further, the recovery is aided with nutritious diet and vitamin supplements. Where were they? Except for Foreign Direct Investment (FDI), nothing much.
No relief from tax terrorism, no reduction or simplification in tax rates, no reduction in operating costs for businesses through reduction in labour costs (payroll deductions), no privatisation, no banking sector reforms. There were lots of promises of reduction in inspector raj. How much of it has materialised? How many laws have been repealed out of the earmarked laws for repeal in the Union government and in State governments?Indian companies were supposed to have one single corporate ID. I doubt if it has materialised too. Happy to be corrected.
I think the government is missing the problem completely. In general, the government has displayed extreme risk-aversion in the design of its schemes, making static assumptions on revenue foregone, etc. No allowance made for improved activity and compliance on account of lower rates, for example. This risk aversion could be the consequence of a controlling or untrusting mindset. Or, it could be the mindset of the senior bureaucrats in the Ministry of Finance who guided many of these policies. Or, they could be simply reflecting the mindset of the Minister concerned or the Prime Minister. Any or some or all of the above could be influential factors.
The truth is that economic uncertainty in India is not an illusion. It is not money illusion that is behind the absence of ‘feel good’. Given all that has happened with government’s policy decisions and legislative changes – good, bad, hasty, measured, sound, unsound – it is just that Achche Din is becoming an illusion. This time, it is not a money illusion but a ‘real illusion’.