Economic reforms: The buck stops here

All is not well with the economy as unemployment has mounted and farm distress widened, with drought looming large in a year of difficult fiscal situation. It's not going to be easy and no quick fix solution is available to the new finance minister Nirmala Sitharaman.

Sitharaman, who presents her maiden Budget on July 5, will have to avoid hasty and disruptive steps as there is no magic wand to speed up economic growth, which can pick up only gradually.

In 1991 when the government had no choice but to embark on major economic reforms, it was done in a non-disruptive and gradual manner, according to renowned economist C Rangarajan. The then Prime Minister Narasimha Rao had the deftness to sell reforms to old guards in the Congress party and made reforms painless with a step-by-step approach.

The present situation is not as bad as 1991, renowned economist Pronab Sen said, adding, "It is still a hangover of demonetisation. Farm and informal sector were badly affected. Consumption comes from lower income and rural group, and that has not started."

The new government's first priority should be to remonetise so that consumption demand is revived.

"Agriculture is the heart of the problem that has to be remonetised. P M Kisan Yojana that provides income support to farmers is a good move, but that is only one part of the solution. The real problem is traders in farm mandis. Traders need a large amount of money for a very short time – at the time of harvesting and sowing. The traders have to be remonetised," Sen told DNA Money.

Lifting Rs two lakh cash limit imposed after demonetisation could go a long way in remonetising farm traders. This can be done even before the Budget. The government should ensure that farm traders are not starved of funds during the short period of two to three weeks during sowing or harvesting.

Due to the Rs two lakh restriction, the traders exploit the farmers who come to mandis for selling their produce. The cash crunch is used to force farmers to make distress sales.

This cap on cash has not hit the construction industry much though wages are paid in cash, but the cash-driven farm sector, where mandis are far away from banks. The traders plead helplessness in making payment to farmers, taking advantage of the restrictions. So the distress sales are happening, not because of excess production but due to "take it or leave it" attitude of traders due to cash crunch.

Jan Dhan Yojana has worked wonders for improving savings of the poor and for direct benefit transfers, but failed to help farmers carry out normal transactions for buying and selling of their produce, which is still in cash. "This is the crux of the farm distress problem and certainly not a demand-supply issue," Sen said.

It's a Catch-22 situation as a result as rural jobs are linked to this issue, Sen said. Nearly 70% of the population lives in rural India, with 41% depending solely on agriculture. So the cash crunch becomes a major issue in running rural economy as it distorts the entire farm market operations.

Water is yet another major issue. With drought looming large for the third consecutive year, it is time the government tackled the problem on war footing. India gets all 80% of its water requirement during the three months of monsoon, unlike in the other parts of the world where it is spread over the year. So rain-water harvesting becomes very important, which means reviving the old practice of having ponds, tanks, lakes all over the country, apart from recharging ground water. Stress on minor irrigation, check dams and linking of rivers is important.

The second term of Modi has started in right earnest by setting up a separate ministry to deal with this grave issue that cannot be tackled overnight. Desalination in coastal areas can help reduce drinking water problem in those areas, but certainly not for agriculture purposes. Nearly 85% of water consumed in India is by agriculture, Sen said, adding there is enough rainwater, but it has to be harnessed properly and adequately.

Micro, small and medium-scale industries (MSMEs) have been badly hit as informal lending has dried up. The problem has been accentuated because of NBFCs, which are in the doldrums.

Large non-performing assets (NPAs) in banks also need immediate attention.

Senior IAS officer and additional secretary V Srinivas quotes the IMF to say that the Indian financial sector is facing considerable challenges of high NPAs. The stress tests showed a group of public sector banks highly vulnerable to further declines in asset quality and higher provisioning needs. This has to be another priority area for Sitharaman, particularly recapitalisation of banks. Srinivas was a former advisor to India's executive director in IMF.

Earlier, NBFCs used to borrow money from the market and lend it to borrowers. From 2005, banks started lending to NBFCs to promote retail banking. NBFCs got used to this cheap lending from banks, resulting in mushrooming of NBFCs. The net result is a huge asset-liability mismatch.

To enable banks to raise long-term deposits to lend to infrastructure, the government should allow banks to raise tax-free bonds from the public as developmental financial institutions were allowed to do so earlier. This will ensure banks do not have asset-liability mismatch. At present, banks raise deposits for short term of 3-5 years and lend long term for infrastructure projects, resulting in the mismatch. Banking law might have to be amended for this purpose.

To deal with bad debts, Sen said banks have no option but to take huge haircuts. But Insolvency and Bankruptcy Code will ensure frauds such as the one by Nirav Modi does not happen. "The long and short of it, now sense has been put into the system," Sen said.

The fiscal situation is not that good. The Budget will not be able to take any more sops. The sensible thing would be to hold on and announce them after well thought out structural reforms are prepared. There is certainly not enough time to prepare them before the Budget.

The fiscal situation can be tackled only gradually, Sen said, agreeing with N R Bhanumurty, economist and official of National Institute of Public Finance and Policy (NIPFP).

Exports too is a problem. This is not the time to revive special economic zones (SEZs). SEZs were started at a wrong time, when the global economy was not favourable. Fixing and revival of rural economy will ensure growth surges to 7-7.5%, and India will need to push exports for any high rate of growth beyond that, Sen said.

On the contentious labour and land reforms, a broad consensus would have to be evolved as in case of GST, he said. A GST Council like body was needed to be constituted for reforms, particularly in labour. For example, Rajasthan has come out with some labour reforms, but a company operating in Rajasthan may be registered in Mumbai, where Maharashtra labour laws apply, which are not changed. The central government, with a clear majority, can nudge state governments and evolve a consensus as in the case of GST to bring about some uniformity, analysts said.

Bhanumurthy, who was among the few economists to forecast that GDP growth would be below 7% in 2018-19, said economic growth will be tepid this year as well because of unfavourable fiscal and farm situation. He told DNA Money it could be as low as 6.6% this fiscal and perhaps worse if a stimulus is not provided through expenditure switching. Unfortunately, the government resorted expenditure contraction to contain the fiscal deficit, which was not good for growth.

"It is very important that the government accepts there is a slowdown. Even to achieve 7% growth this year the government will have to do more. My assessment is 2019-20 will also have less than 7% growth, which is because there is a global slowdown, barring the US. There is also a trade war, which is nastier than expected. All these things will have some impact on exports. A preferential trade agreement with the US too has gone. Oil prices, though falling, are still much higher than the last year. So support for the domestic economy from external factors will be worse this year," Bhanumurty said.

Predictions indicate monsoon will be below normal and sowing may be delayed, which does not augur well for agriculture. Thirdly, there is a continuous slowdown in consumption in rural as well as urban areas, and credit off-take is low, indicating that revival of industrial activity is not all that encouraging, he said.

"All segments of demand are slowing down. On top of it, the government is squeezing its fiscal deficit. So there is a reduction in the level of expenditure. These are reasons why my own model is saying GDP will be less than 7% for the second consecutive year," Bhanumurty said.

He said the way forward is to push consumption demand, one by relaxing the fiscal deficit target and spending more on rural development, particularly in MNREGA programme to put money into the hands of rural poor. The government had done quite a lot for rural development through roads and housing, but more needed to be done to revive MSMEs and rural industries, apart from tackling cash crunch among farmers.

The revival of stalled projects, especially those that can be completed with little more expenditure, should be identified and pursued vigorously to step up growth, he said, adding, remonetisation of the economy, necessary to push growth "will take a little bit of time", he said.

Bhanumurty said there are some problems with the Mudra scheme. The government needs to take corrective measures, as otherwise this could become another problem for the banking sector. Regulation of asset reconstruction companies is needed too.

While Sitharaman has inherited a "weak and distressed economy", Bhanumurty felt she has the ability to convert this into an opportunity. And it is visible that in a short time the Modi government 2.0 has shown a tilt towards real economic issues, he said, adding setting up of Cabinet committees on jobs, skill development, economy and investment is a welcome development.

On the recent RBI rate cuts, analysts said it will not do much until NBFC and banking problems are fixed and more liquidity is made available after pushing the consumption demand for kick-starting the economy.