The year 2017 will be a year to watch. Not because I expect some watershed event to happen, but because of what happened in 2016. The last year was eventful to say the least both within India and outside. The full effect of these events will be felt in the current year. How the future of the world, and India, shapes up will depend on actions and policies of governments across the world. I do not think that any point in the recent past we waited so anxiously to see what governments do - in US, in UK and in India.
FULL COVERAGE: UNION BUDGET 2017-18
As Donald Trump takes over the Presidency in US and Theresa May lays out the plan for Britain's exit from EU, developed countries are all set to change course and become more protectionist. This has grave implications for the whole world, and indeed India. Over the last two decades, the growth in India has picked up. It is no coincidence that India has become a much more open country during that period.
If we look at history of development of countries, there are a few episodes of rapid growth for countries in different eras across the world - from UK post industrial revolutionto the Asian experience in recent times, where trade and openness has played a pivotal role. India is in the middle of such a growth experience. While India's path has been somewhat different in the sense that it has not been led by expansion of manufacturing, the role of openness and international trade cannot be underestimated.
In India, a sudden and unexpected policy announcement by the government - withdrawal of high valued notes amounting to about 86 per cent of currency in the circulation, has created a large degree of uncertainty. This will certainly increase volatility, and all indications point to slowdown in the short run. The business cycles in emerging markets are dominated by shocks to the growth trend rather than transitory shocks around the trend, which is in contrast to developed country business cycles. Will demonetization turn out to be a shock that changes the trend?
With the wave of protectionism spreading in the developed world, and policy induced shock within India, the Indian businesses need to firm up their act and the government its policies to find its way back to high growth rates. The Union Budget, coming early in the year (unless the Election Commission rules otherwise), would be a good place to start, though policy response has to go beyond the budget and involve a systemwide response.
The government needs to formulate measures to tide the headwinds in the short run, as well as ensure that long-term growth is sustained. To understand what measures might work in short term, one has to understand that in emerging markets, including India, both consumption and investment are volatile as opposed to developed countries where consumption is relatively smoother.
So, the government has to find ways to contain volatility of both investment and consumption. The reports in the newspapers suggest that the government might cut corporate tax rate. This surely will give fillip to investment to certain extent, but probably will not be enough by itself. This has to be accompanied by policy rationalizations that reduce frictions in input markets.
FULL COVERAGE: RAILWAY BUDGET 2017-18
For example, look at the distortion ESIC deductions cause. These deductions are made for salaried individuals who earn below a certain threshold. This deduction funds treatment of these individuals and their dependents through ESIC clinics.
While the deductions in absolute terms might be low, but at the lower end of income levels it is not an insignificant share of an individual's income. For the employers this increases administrative cost. The strange thing is that there is no such deduction for higher income group, though everyone has access to government run hospitals and clinics, including very good ones like AIIMS. One bold move would be to create a national insurance market in India.
The Prime Minister had earlier announced a National Health Assurance Mission, which could be expanded. Given large and young population in India, the cost of insurance is expected to be low. Given health shocks are big and often wipe out significant proportion of wealth for people hit by that shock, this will also help smoothen consumption. Additionally, doing away with ESIC deductions and such will induce more investment and employment in the formal sector.
To sustain high growth rates over a long period of time, if there is one sector the government needs to focus on, it is education. In the economics academic literature, while there is a lot of debate about short run business cycles and policies related to that, there is a near unanimity about how vital education is to the growth process. It is even more critical for India because of the demographic structure. We are at the right end of the distribution of demographic structure when compared across other countries in the globe. Our dependence ratio is low - we have many more young people than old. In fact, if you think about it, this is what India's comparative advantage is.
However, that we will gain from this is far from guaranteed. In fact, if we do not act fast, this might as well become a liability, with low development indicators and conflicts. To prevent that, and to ensure we emerge as a more developed country than we are now, education has to play a pivotal role. In recent times school enrollment has gone up significantly, yet the good news stops there.
Report after report has pointed out lack of quality in school education. Many households spend significant proportion of their income on education of their children, often putting them in private schools of dubious nature, chasing the mirage of quality education for their children. Government intervention in this area is a dire requirement.
The role of the central government is limited in this regard, yet there are many things it can do. To begin with it can use its chain of schools, Kendriya Vidyalyas and Sarvodya Vidyalayas to set standards, as well as access. These should become aspirational schools. One important aspect of school education is teacher quality. Here also the central government can set pace by employing and training high quality teachers.
The logical question at this point is how is it all going to be funded. Should the government give up on fiscal prudence and increase borrowing? Should it let the fiscal deficit widen? Research in this area does not point to any acceptable limit for fiscal deficit that is good for long-term growth. However, there are certain costs of increasing fiscal deficit. Higher fiscal deficit will mean banks holding more government bonds, reducing available funds for credits in the economy.
As it is, banks have not increased credit flows to businesses and individuals.This can further squeeze commercial borrowing, which is not desirable, particularly given that private investment has been slow to pick up pace. That leaves the government with more difficult options - increase tax base, reduce inefficiencies, hive off inefficient and loss making government enterprises like Air India. But, does the government haveenough political capital left to do these? The budget, in a few days, will shed more light on this.
(The author is Head of the Department, Economics at Shiv Nadar University)