The Real Economy Holds The Answers

 (The following article appeared in Economic Times on October 2, 2020, per link 

below:https://economictimes.indiatimes.com/news/economy/policy/view-alongside-stimulus-real-economy-bottlenecks-blocking-job-creation-and-output-must-be-removed/articleshow/78450974.cms )

The Real Economy Holds the Answers

 

When our country emerges from Covid-19, we will need high and sustainable economic growth to heal our economy. Can this be achieved by putting money in people’s hands, and stoking demand?

 

Money creation through fiscal and monetary policies should indeed spur domestic demand. However, in the past, we have struggled to grow domestic output and jobs alongside. As a result, inflation, external imbalance and financial instability have periodically resulted, rather than sustainable growth.

 

Alongside any stimulus, we have to address the real economy bottlenecks that come in the way of creating domestic jobs and output.

 

Money and Economic Activity

 

 “Money” in this article refers the total of all bank deposits and currency in circulation. Monetary policy influences credit growth and foreign currency inflows, and hence the creation of money. Fiscal policies can directly impact the quantity of money in the system.

 

Generally, the more the money, the more the economic activity across consumption, production, savings, investments, and trading in assets.

 

Thus, in the eight years from FY06 to FY13, our M3 grew by 17.9% p.a., and our nominal GDP and consumption grew by over 15.0% p.a.

 

Thereafter, from FY14 to FY20, our M3 growth slowed down to 10.5% p.a., and our nominal GDP growth slowed down to 10.8% p.a.

 

However, while money can spur domestic demand and raise nominal GDP in the short run, absent adequate domestic output and jobs, it can also lead to inflation and financial instability. 

 

Money Can’t Buy Us Sustainable Growth

 

For an emerging economy to achieve sustainable growth, domestic output over time has to at least match domestic demand, if not exceed it via net exports. If adequate job creation accompanies this growth in domestic output, a virtuous cycle of demand, supply, savings and investment can ensue.

 

China achieved such a cycle. Over the past 25 years, its money supply grew by 14% p.a., and private consumption by 12% p.a. Alongside, its real economy ensured expansion of domestic output well in excess of domestic demand. In fact, it’s net export of goods and services grew by 10% p.a. over the period, as it became the factory of the world. 

 

In comparison, over 25 years, our money supply grew by 15% p.a., and our nominal private consumption by 12.5% p.a. However, our domestic output – particularly in manufacturing – has struggled to keep pace with our own demand, let alone feed net exports. Instead, our net import of goods and services, largely feeding consumption rather than investment, grew by 23% p.a. over the period.

 

With inadequate output and jobs, periods of high money and demand growth in India have opened up the risk of inflation and strained our external balance.  Between FY06 and FY13, our net imports averaged 4.8% of GDP, while our rural CPI inflation averaged 9.5%. 

 

This is by no means a mercantilist case against imports. This is a case to expand our output and jobs, support higher domestic and external demand, without resorting to import tariffs that crimp our domestic competitiveness or force austerity upon us.

 

Where Has All The Money Gone?

 

Over the years, credit growth, fiscal spending and net foreign currency inflows have all added to our money supply. The money created, however, has not been adequately productive.

 

A chunk of our banking credit from a decade ago have ended up as non-performing assets. Sectors such as power & discoms, telecom, real estate, airline, and MSME continue to soak up bank credit, without concomitant productivity benefits. 

 

Likewise, our larger-than-acknowledged fiscal deficits have largely funded revenue expenditure, rather than productive investments.

 

Finally, over the years, net foreign currency inflows into our country have been dominated by transient and opportunistic “carry” flows. The productivity benefits from such flows are unclear. 

 

While the demand stoked by money creation should have created its own output, we missed the manufacturing bus, and made it easier to import than produce locally. 

 

Let’s Get Real

 

Our real economy needs to respond to money creation with output and jobs. Else, money creation alone risks inflation and financial instability.

 

Notwithstanding some missteps, real sector reforms such as GST, IBC, financial inclusion, and digitization are indeed underway. However, many more bottlenecks still need to be cleared for ‘Atmanirbhar Bharat’ jobs and output to be achieved.

 

First, our financial services ecosystem is in no shape to fund our growth aspirations. The overhang of NPAs need to be addressed with a decisive one-time solution such as a bad bank. We then need banking, governance and market reforms to make the system capable of creating quality money.

 

Next, chronic stresses in real estate, power, telecom, airline & shipping, and MSME need to be addressed. They continue to clog our money, output and job creation.

 

Third, we have to address whatever puts off domestic entrepreneurs and global supply chains from creating output and jobs in India. This calls for persisting with ongoing land, labour, legal, and policy reforms, seeking constant feedback, and doing more as needed. 

 

Finally, we have to invest much more in education, healthcare and nutrition. This would be the best way to lead our children to jobs and output, in a very uncertain future.

 

The more clarity and confidence we have around output and job creation, the easier it will be to create money and stoke demand. Our real economy holds the answers to questions around the appropriate fiscal and monetary policies to pursue.