While assuming the command of the country as Prime Minister, Shri Narendra Modi had promised MPs of his party that he will return with his report card in five years, that is, before the 2019 general elections. Now, three years later, he has said from the ramparts of the Red Fort that he will double the incomes of the farmers in the next 5 years, that is, by 2022. The two statements read together indicate that Mr. Modi expected to give results in 5 years in 2014; he continues to expect to give results after the same 5 years in 2017. The time frame has shifted forward by three years in three years; or that nothing substantial has happened in the last 3 years. One reason is that the economic policies implemented by Mr. Modi are pushing Indian economy into a long-term stagnation.
Undisputedly major improvements in governance have taken place. There is a sense of honesty and desire to achieve results at the higher levels, at least. We are seeing a great improvement in the pace of making highways. The quality of services provided by the railways has improved. There is a sense of optimism all around. Yet this is not reflected in the growth rates. The growth rate in the five years of UPA-II Government was 7.1 percent. The growth rate in the first three years of NDA-II Government was marginally less at 7.0 percent. But the predictions for the present year are dismal. The Government itself has admitted that 7 percent is not likely to be achieved in the current year. Other analysts expect 6 to 7 percent. My own assessment is that our growth rate will remain around 5 percent. It is surprising that improvement in governance is not helping lift the growth rate.
The reason lies in the economic policies implemented by Mr. Modi. The two major initiatives taken by him are demonetization and the implementation of GST. These have killed the economy. The simple formula of economic growth is to reduce consumption and increase investment. Say, a shopkeeper earns Rs 10 lakhs in a year. He will have a high growth rate if he uses the income for investment. His sales will increase, for example, if he uses his income to install an air-conditioner in his shop. On the other hand, his growth rate will become negative if he uses the income to consume imported liquor. He will not be able to buy goods to stock up the shop, his shelves will be empty and his sales will decline.
We have to assess the impact of demonetization and GST on the economy in this framework. The stagnancy in growth rate means that we, the country as a whole, are investing less and consuming more. The “country” includes both the people and the government. Demonetization and GST have brought more people in the tax net and shifted the national income from the people to the Government. This is how it is happening.
Let us say a businessperson was earning Rs 10 lakhs previously. He was showing an income of Rs 5 lakhs only in his income tax return, and paying an income tax of Rs 20,000 on the same. He intended to invest in installing an air-conditioner in his shop. But then demonetization and GST happened. He now had to declare his full income of Rs 10 lakhs and pay an income tax of Rs 1,20,000 on the same. The cash in his hand declined by Rs 1 lakh and he could not install the air-conditioner. He also could not buy goods to stock up the shelves in his shop. His business declined. This was one part of the story. Now the Government had an additional income of Rs 1 lakh. Say, the Government used this money to buy Rafale fighter jet planes. The money went out of the country. In the result the Indian economy has contracted.
Now consider a different scenario. Let us say a retired pensioner was earning Rs 10 lakhs previously. He was buying liquor worth R 1 lakh out of this receipt every year. Then demonetization and GST happened. The cost of goods consumed by him increased because of higher taxes collected by the government. He faced a loss of income of Rs 1 lakh and could not buy liquor. This was one part of the story. Now the Government had an additional income of Rs 1 lakh. Say, the Government used this money to make cemented roads in the slums. Demand for cement was created in making these roads. The business of small shops operating from the slums increased. In such a situation, the Indian economy would have grown.
The fact that the growth rate is declining under the stewardship of Mr. Modi means that the national income is being used more for consumption and less for investment. This decline is wholly due to increased consumption by the Government because there is a shift in income from the people to the Government. The investment by private businesses is declining due to higher tax collection; and the Government is consuming more. Thus there is stagnation in growth rates. I give below some of the many ways that the government consumption has increased under Mr. Modi; and also a few suggestions how this trend can be reversed.
One, the expenditure in imports of defense equipment has increased. This is laudable in view of the increased threats being faced by us. But that does not change the hard reality of economics. These purchases are leading to outflow of our income. The way out is to purchase defense equipment from domestic manufacturers insofar as possible even if these are more expensive. Domestic purchases will jumpstart the economy.
Two, huge amounts of monies are being spent by the Government in recapitalizing Public Sector Banks and supporting loss-making PSUs like Air India. The Government proposes to handle this problem by merger of loss-making PSBs with larger profit-making PSBs. But that only hides the losses. The way forward is to make a strategic disinvestment of all loss-making PSUs, including the banks. This will provide money to the government to make further investments. The use of the income of the government to support consumption by public sector bureaucracies must stop.
Three, the Government continues to pay increasing salaries to government servants. Large numbers of surplus employees of the government or the PSUs are being offered voluntary retirement packages imposing further burden on the government. The way forward is to put all surplus government employees in a central pool and allot them to those departments where they can be deployed productively, for example, in conservation of forests. Many more suggestions can be given. The bottom line is that the policies of Mr. Modi are leading to a decline in the growth rate.
The author was formerly Professor of Economics at IIM Bangalore