"We ought to be a bit more careful in attributing everything to the economy"

Edited excerpts from conversations with the chief economic advisor, Krishnamurthy Subramanian, on the state of the economy

Vishal Koul

Given the current economic scenario, is the ‘$5 trillion by 2025’ dream still alive?

We will have to grow near 8% in real GDP terms to achieve this goal. Since World War II, any country that grew over 6% has followed an investment-driven model, including India. In advanced economies, consumption is driving growth because they are at a particular stage of economic evolution. But if you compare countries that were at our stage and then grew, consumption is just a force multiplier, not a sustained driver of growth. For instance, China’s consumption as percentage of GDP has secularly declined since the ’80s. Domestically, if you are not consuming much while investing more, you have to save more. In such a case, exports become a critical driver of growth. So, in the Indian context, we argued that an economy is either in a virtuous cycle when they’re doing well, or in a vicious cycle like we saw during the financial crisis. The virtuous cycle starts from investment, and investment enhances productivity, and that’s what leads to export. So, economic growth has to come from investments.

Where will the Rs.20 trillion investment in infra come from when the government and the corporate sector balance sheets are constrained?

I think it’s important to understand why the investment slowdown happened, and what will change that. Around 2008, the investment to GDP ratio was at 38%, which has clearly gone down. History will mention 2009-2014 as a period of poor governance when we went berserk in terms of lending even as some decisions did not make commercial sense. India Inc built up a lot of capacity and ramped up leverage, impairing balance sheets of corporates and impacting the books of banks as well. Cleaning up the mess that got accumulated over a six-year period cannot happen in a jiffy. Now, through the bankruptcy code, asset quality review and capital infusion, the system is being cleaned up. But the absence of strong balance sheets has impacted corporates’ ability to invest.

So, what do you think needs to be done to spur investment?

Two things have to happen. First, very little equity has been coming in, compounded through gold plating (inflating costs) of some projects. Hence, more equity needs to come in so corporate balance sheets improve. Second, once capacity utilisation reaches close to 85%, the investment cycle will resume. 

How and when do you see revival in investment cycle? 

Well, the current situation has been exacerbated by the NBFC crisis, which has impacted credit flow in the economy. Note that credit has grown near 12% over the past one year even as public sector banks have been recapitalised to the extent of Rs.700 billion. But, for the economy to grow nominally at 12%, credit needs to grow at about 18%. So, once credit starts growing, private investment will recover substantially.

But credit transmission is not happening yet. 

Over the past few quarters, the rate cuts have proved to be beneficial. Nobody has a crystal ball, but things should start looking up as transmission begins in the next six months. But predictions about the future are but predictions. 

The pain in the auto sector is worsening with every passing day.

Even in a country such as China, auto sector has significantly slowed down because the models are changing. People are moving towards shared mobility and electric vehicles are also on the rise. So, we ought to be a bit more careful in attributing everything to the economy.

What do you think of real estate? 

Real estate is going through a clean-up because of Real Estate Regulatory Authority (RERA) act, and is not only reflective of what’s happening in the economy. The old model of doing business without caring about the merit of the project or capital allocation won’t work. Without fixing the wrong, we cannot ensure sustained growth at 8%. 

Exports, too, have been hit. What do you think will revive that?

In the third chapter of the Economic Survey, we have dwelled on productivity. Today, in the manufacturing space, firms with less than hundred employees occupy 85% of the sector, and yet their contribution to net value added is less than 13%. A key factor that drives productivity is economies of scale, and these firms are not utilising that. 

An international consumer will buy our product only if it is relatively more productive than domestic manufacturing. So, sustained improvement in exports cannot come unless we focus on this dimension. In the short-term, steroids can give comfort, but you see the side effects only when it wears off. So, we need to focus on long-term competitiveness rather than hankering over tax sops. Our policies have basically created a lot of dwarfs (old firms with less than 100 employees), and we cannot achieve $5 trillion goal merely on palliatives. 

So, are incentives adversely impacting SMEs?

Due to vulnerabilities, SMEs destroy a lot of jobs even though they are perceived as major job creators. In fact, 85% of SME firms contribute only 23% to overall employment. This has an impact on exports and jobs. In the US, a five-year-old firm with less than 100 employees would have at least 750 by the time it’s 40 years old. But in India, that firm would only grow to 140 employees. That’s because these decades-old policies have been sending a message that becoming larger will make them miss out on benefits.

The CEA survey states nearly six million jobs have to be created annually over the next decade. How will we achieve that with rising disruption? 

That’s why we are focusing on structural aspects that will be conducive for MSMEs to become large and provide more jobs. Also, the fear that technology will hurt jobs is unfounded. If ATMs replaced tellers, their introduction created a whole host of new jobs. With technology, the nature of jobs changes. In the case of AI or machine learning, we will need people to put the data together, maintain large servers, and ensure data privacy. So, there are many collateral jobs that get created with technology. 

You mentioned the role of behavioural science, especially with respect to social programmes. How will that translate into economic growth?  

Research shows that a productive population is healthy and educated. So, social or human capital has a huge impact on productivity. Even if we were to focus only on social sector, it will matter for economic growth. Behavioural economics has really worked in enhancing tax compliance globally. In fact, professor Cass Sunstein, the author of Nudge, who also set up the Nudge unit in the Obama administration, has said that behavioural economics can have an impact on growth. In India, it can be really huge because we are a very old country and a lot of our behaviour is driven by norms, whether it’s social, cultural or spiritual.

While the bigger picture of where we are headed is clear, isn’t there too much uncertainty when it comes to the present?

We often tend to oscillate between irrational exuberance and pessimism. Irrational pessimism is not right either. We need to recognise that there are very few or almost no other economies as big as India that can grow at 6% and above. With so much liquidity, investors are looking for places where the economy can grow in excess of 3%. Even with the slowdown, we will continue to grow at 6%. So, let’s not lose cognisance of that fact.


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