Chapter 01- Economic Outlook and Policy Challenges – Highlights of Economic Survey 2016-17

Economic Outlook and Policy Challenges

Briefly on the chapter:

The Economic Survey of 2014-15 spoke about the sweet spot for the Indian economy that could launch India onto a trajectory of sustained growth of 8-10 percent.

The “Sweet Spot” mentioned in 2014-15 aroused out of the following factors:

• A Strong Political Mandate the Modi government received in the elections held in 2014
• Favourable external environment arising out of the fall in oil prices

Now, the Survey in the first chapter,  admits that there requires a policy shift as the external environment is rapidly fluctuating. The rise in oil prices, the not so celebrated “Brexit” and the U.S presidential elections and the possible shift in policies all may lead to the soon fading out of the Sweet Spot, we had in the previous two years.

This first chapter articulates briefly on all that important points which played vital role in shaping the government policies on Indian Economy. So to say, this chapter will serve as the guideline to all other chapters.

The year was marked by two major domestic policy developments:

• the passage of the 101th Constitutional Amendment Act,Goods and Services Tax (GST)
• the action to demonetise the two highest denomination notes.

What GST unfolds for the Indian Economy?

• a common Indian market
• improve tax compliance and governance
• boost investment and growth
• a bold new experiment in the governance of India’s cooperative federalism.

Important points to remember in chapter 1 of economic survey 2016-17 for Civil Services Examination.

The first key focus of the Survey is in discussing the aftermath of demonetisation drive.  

Termed as a “radical governance-cum-social engineering measure” the demonetisation principally was one among many actions taken by the Government in curbing black money.

What were the aims of the demonetisation ?

According the Economic Survey 2016-17 the aim behind the demonetization of two high valued currencies were fourfold:

• To curb corruption
• counterfeiting,
• the use of high denomination notes for terrorist activities,
• and especially the accumulation of “black money”, generated by income that has not been declared to the tax authorities.

The others measures aimed at curbing such illicit activities include:

• creation of the Special Investigation Team (SIT) (2014 budget);
• The Black Money Act, 2015;
• The Benami Transactions Act of 2016;
• The information exchange agreement with Switzerland;
• Changes in the tax treaties with Mauritius and Cyprus;
• The Income Disclosure Scheme.

This unprecedented demonetisation policy move have landed government in public debate . The public debate on demonetisation was primarily revolving on 3 questions:

• Management :design and implementation of the initiative.
• Economic Impact : Short & Long term
• Broader vision as to implication on future economic policy

An analysis of debates leads to a broad conclusion that it “create short-term costs and provide the basis for long run benefits”.

What are the short term costs of demonetization as per the Survey?

Inconvenience and hardship, especially those in the informal and cash-intensive sectors of the economy who have lost income and employment.

(This is less reflected in the GDP, because national income accounts estimate informal activity on the basis of formal sector indicators, which have not suffered to the same extent.)

What are the long term gains of demonetization as per the Economic Survey 2016-17?

• Reduced corruption,
• Greater digitalization of the economy,
• Increased flows of financial savings,
• Greater formalization of the economy

All the above factors could eventually lead to higher GDP growth, better tax compliance and greater tax revenues.

What are the actions to be taken to reduce the pain and increase the gains of demonetization?

The following actions are to be taken:

1. Re-monetizing the economy expeditiously by supplying as much cash as necessary, especially in lower denomination notes;
2. Complementing demonetisation with more incentive-compatible actions such as: bringing land and real estate into the GST,
3. reducing taxes and stamp duties,
4. ensuring that the follow-up to demonetisation does not lead to over-zealous tax administration.

Broad vision as to Implication of future economic policy:

The question of broader vision is critical to shaping the medium term trajectory of the economy. Towards this, the government had taken the following steps:

1. The GST bill, which will create a common Indian market, improve tax compliance, boost investment and growth – and improve governance;
2. New bankruptcy laws to end the “exit” problem that pervades the Indian economy–that has caused  deleterious consequences highlighted in last year’s Survey.
3. Monetary Policy Agreement between the Government and RBi -to consolidate the gains from macroeconomic stability by ensuring that inflation control will be less susceptible to the whims of individuals and the caprice of governments
4. Legal Basis for Aadhar :  to realise the long-term gains from the JAM trifecta (Jan Dhan-Aadhaar-Mobile), as quantified in last year’s Survey.
5. The government enacted a package of measures to assist the clothing sector that by virtue of being export-oriented and labor intensive could provide a boost to employment, especially female employment.
6. Unified Payments Interface (UPI) platform has been finalised by  National Payments Corporation of India (NPCI) :By facilitating inter-operability it will unleash the power of mobile phones in achieving digitalization of payments and financial inclusion, and making the “M” an integral part of the government’s flagship “JAM”-Jan Dhan, Aadhaar, Mobile– initiative.
7. FDI reform measures were implemented, allowing India to become one of the world’s largest recipients of foreign direct investment.

With the above said measures taken by the government , India is not only among the world’s fastest growing major economies, underpinned by a stable macro-economy with declining inflation and improving fiscal and external balances.

Yet there is a gap between this reality of macro-economic stability and rapid growth, on the one hand, and the perception of the ratings agencies on the other. In India’s aim to realize its ambitions on growth, employment and social justice, India faces challenges which needs to be addressed.

Challenges identified by the Economic Survey 2016-17 in the Indian economy

Broader societal shifts are required in ideas and narratives to address three major challenges:

Reducing “inefficient redistribution,”

The central government alone runs about 950 central sector and centrally sponsored schemes and sub-schemes which cost about 5 percent of GDP. But many have intrinsic limitations as to targeting the beneficiaries.  Aadhar law is a life saver in the case.

Strengthening state capacity in delivering essential services and regulating markets,

On state capacity, delivery of essential services such as health and education, which are predominantly the preserve of state governments, remains impaired.

Competitive populism needs a counterpart in competitive service delivery.

Some successful examples in service delivery as quoted in the Survey are,

1. the improvement of the public distribution system (PDS) in Chhattisgarh,
2. the incentivization of agriculture in Madhya Pradesh,
3. reforms in the power sector in Gujarat which improved delivery and cost recovery,
4. the efficiency of social programs in Tamil Nadu,
5. the recent use of technology to help make Haryana kerosene free.

Dispelling the ambivalence about protecting property rights and embracing the private sector.

The issues in the lack of ambivalence towards private sector are manifested in the following issues:

1. the difficulties in advancing strategic disinvestment;
2. persistence of the twin balance sheet problem—over-indebtedness in the corporate and banking sectors.
3. the legacy issues of retroactive taxation
4. agriculture, where the protection of intellectual property rights, for example in seeds, remains a challenge;
5. reform in the civil aviation sector, which has been animated as much by an interventionist as liberalizing spirit;
6. in the fertilizer sector, where it is proving easier to rehabilitate unviable plants in the public sector rather than facilitate the exit of egregiously inefficient ones;
7. frequent recourse to stock limits and controls on trade in agriculture, which draws upon the antiquated Essential Commodities Act, and creates uncertainty for farmers

Reestablishing private investment and exports as the predominant and durable sources of growth is the proximate macro-economic challenge.

Global Context and Indian Economy

“Risk unleashing paradigmatic shifts in the direction of isolationism and nativism” – this sentence in the Survey explains the evolving global environment.

The three main global developments are as follows:

1. US elections and the implied change in expectations of US fiscal and monetary policy  with high expectations of fiscal stimulus and unwavering exit from unconventional monetary policies.
2. “political carrying capacity for globalisation” have changed.  In the short run a strong dollar and declining competitiveness might exacerbate the lure of protectionist policies.
3. The rise in dollar and implications for China’s currency and currency policy.

What is “political carrying capacity for globalisation” ?

If asT.S. Eliot said that “humankind cannot bear too much reality”, recent events suggest that the world cannot bear too much globalisation either.

• There were two phases of globalisation (1870-1914, 1945-1985),
• one phase of hyper globalisation between 1985-2008, and one phase of deglobalisation in the interwar period.

The question today is what is likely to happen going forward

• Further globalisation?
• Deglobalisation?
• or stagnation?

The answer to these questions will have potentially important consequences for Indian exports and growth.

Review of Developments in 2016-17

Outlook for 2016-17

Demonetisation affects the economy through three different channels.

1. An aggregate demand shock – because it reduces the supply of money and affects private wealth, especially of those holding unaccounted money;
2. An aggregate supply shock – to the extent that economic activity relies on cash as an input.
   • For example, agricultural production might be affected since sowing requires the use of labour traditionally paid in cash;
3. An uncertainty shock – because economic agents face imponderables related to the magnitude and duration of the cash shortage and the policy responses (perhaps causing consumers to defer or reduce discretionary consumption and firms to scale back investments).

Impact on supply of cash and money and interest rates

1. It has reduced sharply – cash—while increasing almost to the same extent another type of money—demand deposits.
2. The decline in interest rates on the lending rate (based on the marginal cost of funds) by 90 basis points since November 9; on deposits (by about 25 basis points); and on g-secs on the other (by about 32 basis points)
3. India’s stock market had declined by 0.93 percent

Impact on GDP

To explain the impact on GDP, the Survey has taken 5 broad indicators

1. Agricultural (rabi) sowing; – Wheat and pulses sowing has exceeding last year’s planting figures.But the increase in production depends upon whether farmers’ access to inputs—fertilizer, credit, and labour—was affected by the cash shortage.
2. Indirect tax revenue, as a broad gauge of production and sales.
   • Passenger car sales and excise taxes bear little imprint of demonetisation.
   • Auto sales, as a measure of discretionary consumer spending and two-wheelers, as the best indicator of both rural and less affluent demand;
   • Sales of two wheelers has come down. 
3. Real credit growth – Credit was already looking weak before demonetisation, and that pre-existing trend was reinforced.
4. Real estate prices : it has fallen in cities. 

Recorded GDP growth in the second half of FY2017 will understate the overall impact because the most affected parts of the economy—informal and cash-based— are either not captured in the national income accounts or to the extent they are, their measurement is based on formal sector indicators.

Outlook for 2017-18

Real GDP

1. India’s exports appear to be recovering, based on an uptick in global economic activity. This is expected to continue in the aftermath of the US elections and expectations of a fiscal stimulus.
2. Private consumption will be affected by rising international oil prices, but  is expected to receive a boost from two sources: catch-up after the demonetisation-induced reduction  and cheaper borrowing costs.
3. Since no clear progress is yet visible in tackling the twin balance sheet problem, private investment is unlikely to recover significantly from the levels of FY2017.

Thus the Economic Survey expect real GDP growth to be in the 6¾ to 7½ percent range in FY2018. Even under this forecast, India would remain the fastest growing major economy in the world.

There are three main downside risks to the above forecast.

1. Effects of demonetisation could linger into next year, especially if uncertainty remains on the policy response.  Currency shortages also affect supplies of certain agricultural products, especially milk (where procurement has been low), sugar etc. It is essential to prevent “another pulses episode” with respect to agricultural products.
2. Geopolitics could take oil prices up further than forecast. It will eat into our import bills resulting reduced consumption; less room for public investment; and lower corporate margins, further denting private investment.
3. Risks from the possible eruption of trade tensions amongst the major countries, triggered by geo-politics or currency movements. This could reduce global growth and trigger capital flight from emerging markets.

Fiscal outlook

1. The increase in the tax to GDP ratio of about 0.5 percentage points in each of the last two years will disappear due to increase in oil prices.
2. There will be a fiscal windfall both from the high denomination notes that are not returned to the RBI and from higher tax collections as a result of increased disclosure under the Pradhan Mantra Garib Kalyan Yojana (PMGKY).
3. A third factor will be the implementation of the GST. The transition to the GST is so complicated from an administrative and technology perspective that revenue collection will take some time to reach full potential.

How to use the ‘fiscal windfall’[comprising the unreturned cash and additional receipts under the PMGKY] as per the Economic Survey 2016-17?

Since the windfall is not an income gain, it should be deployed to strengthening the government’s balance sheet rather than being used for government consumption, especially in the form of programs that create permanent entitlements.

In this light, the best use of the windfall would be

• to create a public sector asset reconstruction company so that the twin balance sheet problem can be addressed, facilitating credit and investment revival;
• or toward the compensation fund for the GST that would allow the rates to be lowered and simplified;
• or toward debt reduction.

The macroeconomic policy stance for 2017-18

An economy recovering from demonetisation will need policy support.  Since the central government fiscal deficit started declining from 4.5 percent of GDP in 2013- 14 to 4.1 percent, 3.9 percent, and 3.5 percent in the following three years, fiscal policy needs to balance the cyclical imperatives caused by demonetisation.

Labour Reforms

A  move towards affording greater choice to workers which would foster competition amongst service providers. Choices would relate to:

• whether they want to make their own contribution to the Employees’ Provident Fund Organisation (EPFO);
• whether the employers’ contribution should go to the EPFO or the National Pension Scheme;
• whether to contribute to the Employee State Insurance (ESI) or an alternative medical insurance program;

Also there could be a gradual move to ensure that at least compliance with the central labour laws is made paperless, presenceless, and cashless.

Other Issues

1. Redistribution: Universal Basic Income (UBI) as a radical new vision.

This misallocation of funds has consequences:

1. It results in exclusion of the deserving poor from access to government welfare benefits,
2. Leakages to non-poor and benefits to corrupt local actors.

One of the key problems with many programs is that the take-up and effectiveness of targeting will be correlated with a state’s institutional and implementation capacity.

Thus the Economic Survey moots new idea of a universal basic income as a more effective way of achieving Mahatma Gandhi’s objectives of “wiping every tear from every eye.”

Understanding UBI

A UBI will not necessarily be driven by take-up capability from below but given from above to all the deserving. In that sense, it is less likely to be prone to exclusion errors. And by directly transferring money to bank accounts, and circumventing multiple layers of bureaucracy, the scope for out-of system leakages (a feature of PDS schemes) is low.

2. Exchange rate policy: Vigilance and new ways of monitoring

Given India’s need for exports to sustain a healthy growth rate, it is important to track India’s competitiveness.

A second reason to review India’s competitiveness is the rise of countries such as Vietnam, Bangladesh, and the Philippines that compete with India across a range of manufacturing and services.

The policy implication is that if India is concerned about competitiveness and the rise of exporters in Asia, it should monitor an exchange rate index that gives more weight to the currencies of these countries

3. Trade Policy

Aftermath of Brexit and the US elections.  – These are likely to be exacerbated by macro-economic developments in the United States.

Two specific opportunities arise.

1.  More proactively seek to negotiate free trade agreements with the UK and Europe (given the the need to promote labor-intensive exports).

The potential gains for export and employment growth are substantial.

2. The likely US retreat from regional initiatives such as the Trans-Pacific Partnership (TPP) in Asia and the Trans-Atlantic Trade and Investment Partnership (TTIP) with the EU.

It is possible that the relevance of the World Trade Organization might increase. As a major stateholder and given the geo-political shifts under way, reviving the WTO and multilateralism more broadly could be proactively pursued by India.

4. Climate Change and India

The Paris Agreement on climate change in December 2015 has been one of the shining recent examples of successful international cooperation. The focus will now shift to implementing the agreements.

The increase in petrol tax has been over 150 percent in India. In contrast, the governments of most advanced countries have simply passed on the benefits to consumers, setting back the cause of curbing climate change.

5. Ensuring Women’s Privacy

In FY2015, it highlighted the violence against women related to coercive family planning methods.

In FY2016, the Survey featured a chapter on “Mother and Child,” emphasizing the importance of government interventions to ensure long term well-being of women and children.

Women’s personal hygiene is  important not just for better health outcomes but also for the intrinsic value in conferring freedom that comes from having control over their bodies, a kind of basic right to physical privacy. Put differently, impeded access may well be creating “gender-based sanitation insecurity.”

The Disproportionate Burden on Women

1. Households without toilets : 33 percent of the women have reported facing privacy concerns and assault while going out in the open.
2. Household with toilets:  In rural households, the proportion of regular use by women was 56 percent (men, 43 percent); and in urban households, 75 percent of women reported exclusive usage (men, 72 percent). What this pattern of usage suggests is that women and girl-children could take a key leadership role to play in Swachh Bharat’s objective of creating defecation free communities, by nudging men and boys of the household to change their own defecation behaviors.

What Economic Survey suggests as a solution?

• Acknowledge the problem.

This means generating more information on a topic that is socially considered taboo or ignored.

• Recognizing the positive behavioral patterns that women demonstrate upon obtaining access to sanitation services is critical. Equally, when these services are denied, they face considerable insecurity and nutritional risks. For this reason, ensuring safe and adequate sanitation, water security and hygiene—the objectives of Swachh Bharat—as part of a broader fundamental right to privacy is becoming a serious policy issue.

6. India’s Soon-to-Recede Demographic Dividend

2016 was a turning point in global demographic trends. It was the first time since 1950 that the combined working age (WA) population (15-59) of the advanced countries declined (Ip(2015)).

Over the next three decades, the United Nations (UN) projects that China and Russia will each see their WA populations fall by over 20 percent.

India, however, seems to be in a demographic sweet spot with its working-age population projected to grow by a third over the same period; always remembering that demography provides potential and is not destiny.

Younger populations are more entrepreneurial (adding to productivity growth); tend to save more, which may also lead to favourable competitiveness effects.

There is a clear divide between peninsular India (West Bengal, Kerala, Karnataka, Tamil Nadu and Andhra Pradesh) and the hinterland states (Madhya Pradesh, Rajasthan, Uttar Pradesh, and Bihar). The peninsular states exhibit a pattern that is closer to China and Korea, with sharp rises and declines in the working age population.

Demographically speaking, therefore, there are two Indias, with different policy concerns: a soon-to-begin-ageing India where the elderly and their needs will require greater attention; and a young India where providing education, skills, and employment opportunities must be the focus.  Of course, heterogeneity within India offers the advantage of addressing some of these concerns via greater labour mobility, which would in effect reduce this demographic imbalance.

The growth boost from the demographic dividend is likely to peak within the next five years, as India’s share of working-age population plateaus.

Also Read : Top 10 Key Highlights of Economic Survey 2016-17 for UPSC Aspirants

Also Read: Chapter wise highlights of Economic Survey 2016-17

Chapter 01 – Economic Outlook and Policy Challenges

Chapter 02 – The Economic Vision for Precocious, Cleavaged India

Chapter 03 – Demonetization: To Deify or Demonize?

Chapter 04 – The Festering Twin Balance Sheet Problem

Chapter-05 – Fiscal Framework: The World is Changing, Should India Change Too?

Chapter 06 – Fiscal Rules: Lessons from the States

Chapter 07 – Clothes and Shoes: Can India Reclaim Low Skill Manufacturing?

Chapter 08 – Review of Economic Developments

Chapter 09 – Universal Basic Income

Chapter 10 – Income, Health, and Fertility: Convergence Puzzles

Chapter 11 – One Economic India

Chapter 12 – India on the Move and Churning

Chapter 13 – The ‘Other Indias’ – Highlights of Economic Survey 2016-17

Chapter 14 – From Competitive Federalism to Competitive Sub-Federalism