Business Cycles, Structural Issues and Challenges to Bharat’s Economy

Business cycles are common across the world and their pattern is mostly predictable. Whereas, structural issues are those that are caused by certain changes in the market which are basic or fundamental in nature. For instance, liberalization of Bharat’s economy in 1990s that led to abolition of license raj, shift from highly regulated foreign trade to free trade are few examples for structural changes.

Post liberalization, entry of new private sector banks led to stiff competition and the highly technology driven new private sector banks had transformed the banking industry by launching flexible and innovative financial products leading to anywhere and anytime banking. This compelled the old private sector banks and PSBs to automate their banking operations and shift to technology driven banking.

The Bharatiya banking during this period faced a major challenge in the form of reluctance of the workforce to upgrade their skills to handle the new technology. Workforce also resisted the attempts of bank managements in introducing technology as they felt it as a threat for their very survival. The bank managements had to assure the workforce that they would not lose the jobs and even offered them incentives to upgrade their skills to handle the technology.

This shift in Bharat’s banking post liberalization from manual operations (labour) to technology driven banking (capital) is an example of structural shift. Similarly, the proposed electric vehicles will lead to a disruptive change and structural shift from the existing fossil fuel driven vehicles in the automobile sector. 

An economy basically undergoes cyclical and structural changes over a period of time. While the cyclical changes happen quite frequently at predictable intervals and are transitory the structural changes are normally not frequent but of longer duration and many times a painful process. The cyclical changes keep repeating (e.g., from growth to recession) whereas the structural changes are both disruptive and transformative in nature.

Cyclical changes happen due to factors like- growth, boom, recession and depression mainly caused by the mismatches between the market demand and supply conditions. A country can manage the cyclical changes caused by domestic market much easily compared to global markets. Due to globalization and integration of the domestic economies with global economy, of late, one finds structural changes too have become more frequent caused by factors like disruptive technologies, changes in the lifestyles of the people, etc. 

It will be interesting to observe the policy responses initiated by the governments and the regulators with regard to cyclical changes. When the economy is passing through growth and boom it is the tendency of the governments and the regulators to go easy and even ignore the symptoms of recession due to the climate of optimism and positivity that prevails in the economy. Whereas the moment recession starts stepping in and moves towards depression the governments and the regulators give knee jerk reactions and start taking stringent measures since the overall market climate in such a scenario is that of pessimism and negativity.

Such an approach is in a way either reactive or inactive in nature. The ideal approach should be to adopt strategies to extend the growth and boom phases of the business cycles and attempt to cut short the recession and depression through pro-cyclical and counter- cyclical policies respectively.

While the business cycles cannot be avoided at least the growth phase can be extended and the recession can be cut short if the governments and regulators adopt proactive measures. Unfortunately as the history of global economy indicates governments and the regulators tend to ignore the early warning symptoms.

Unchecked aggressive lending towards mortgage loans in US prior to 2007 and highly leveraged infrastructure funding by Indian banks during 2003-2012 that was followed by subprime crisis in US and large NPAs in infrastructure sector in India respectively are classic examples worth mentioning in this context. 

Growth, Inflation and Interest Rates

Once the decline in economy steps in and the mood of panic and pessimism spreads the market the financial sector and the banking regulators are the first to become cautious. This justifies the proverbial saying “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”–Mark Twain.

Whereas the governments normally take more time to formulate the appropriate policies to arrest the decline in economy and in the meanwhile, the cautious approach of the bankers and banking regulators leads to further complications in the market that is already in panic mood.

As long as the inflation is low and lesser than the economic growth (and also when the economic growth is increasing) increase in interest rates may not prove to be deterrent for the private sector to borrow from the banks. On the contrary once the economic growth starts declining decrease in interest rates may not induce the private sector to borrow additional funds. 

Bharat’s economy is currently witnessing this situation where the continuous reduction of interest rates (RBI, fourth time in a row since February, 2019 has reduced the key policy rates cumulatively amounting to 110 bps) by the RBI and the banks has not succeeded in arresting the declining GDP growth nor has it resulted in the private sector borrowing more to step up the investment to boost GDP growth.

Therefore, when there is decline in economic growth the banks are reluctant to lend and the private sector is cutting down the production which in turn results in further decline in economic activity eventually leading to job losses followed by recession. Bharat is precisely in this precarious spot and now witnessing challenges that are caused by both cyclical and structural factors.

Lower Tax collections, Rising Fiscal Deficit and Shrinkage in Capital Expenditure

Dwindling tax revenues of the government due to shortfall in direct and indirect tax collections to the tune of Rs.1,52,000 crores in 2018-19 has led to government’s cutting down its expenditure from the estimates of Rs. 24.57 lakh crore to Rs. 23. 11 lakh crores during this period in order to meet its fiscal deficit target of 3.4% of GDP.

Government is able to maintain its fiscal deficit target in 2018-19 mainly due to keeping significant revenue and capital expenditure outside the budget. In 2017-18, government expenditure went up 14.97%, while GDP growth was at 7.17%. whereas, as per cent of GDP, total Central Government expenditure fell by 0.3 percentage points in 2018-19 (provisional) over 2017-18, with 0.4 percentage point reduction in revenue expenditure and 0.1 percentage point increase in capital expenditure.

Bharat’s fiscal deficit numbers have come under sharp scrutiny of CAG as the government has been increasingly depending on off-budget borrowings to fund capital expenditure and even revenue expenditure such as food and fertiliser subsidy arrears. As per CAG presentation to 15th Finance Commission the actual fiscal deficit for the year 2017-18 works out to 5.85% as against the claim of the government of 3.46%. 

The CAG has also found that the revenue deficit in 2017-18 was actually 3.48% of GDP and not 2.59% as reported. The central government’s total expenditure (both revenue and capital) has been declining sharply since 2010-11. From a high of 15.4% of the GDP in 2010-11, the total expenditure has hit a low of 12.2% of the GDP in 2018-19. The capital expenditure component has dropped from 2% of the GDP in 2010-11 to 1.6% in 2018-19 and that of the revenue expenditure from 13.4% in 2010-11 to 10.6% in 2018-19.

Stalled and Delayed Central Sector Projects

As per the MOSPI’s (Ministry of Statistics and Project Implementation) March, 2019 flash report for the ongoing central sector projects costing Rs.150 Crores and above numbering 1405 , 340 projects have cost overrun to the tune of Rs.3.30 lakh Crores. “Total original cost of implementation of the 1405 projects was Rs 18,09,681.47 Crore and their anticipated completion cost is likely to be Rs 21,39,924.38 Crore, which reflects overall cost overruns of Rs 3,30,242.91 Crore (18.25 percent of original cost),”

Solution

The need of the hour is to step up the government expenditure particularly the capital expenditure to give a demand push to the economy. The government has to speed up the completion of these central sector projects and infuse the required funds to avoid further delays in time and cost overruns.

The government can put in fast track the PPP projects falling in the above mentioned central sector projects and persuade the RBI to direct the banks to lend the required (additional) funds by restructuring these projects and if required treating them as national priority projects. This will revive the activity in these stalled projects leading to employment and pick up in the demand for steel, cement and other construction material/ equipment manufacturing sectors and give the required push to step up the demand in the economy.

Additionally the money that is expected to be received by the government from RBI amounting to Rs. 1.76 Lakh Crores can be earmarked to spend for the EPC projects that fall under the stalled and delayed central sector projects. Simultaneously the government has to take immediate measures on priority basis to boost the farming and MSME sectors that have the potential to step up the demand in the economy and in turn help the nation in creation of jobs.

These steps suggested above if implemented will certainly give the required demand push to the Bharatiya economy and also address the challenge of growing unemployment. Hope the government and the regulators will have a serious thinking on this and take suitable measures to revive the economy.

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About the Author

B.N.V. Parthasarathi
Ex Senior Banker, Management and Financial Consultant, Visiting faculty at premier B Schools and Universities. E mail- [email protected]