Recapitalisation, infrastructure and the excess capacity in the economy...

The FM announced big packages for PSBs and infrastructure few days back which received overwhelming response from all sides and the stock market too saw jump in the index buoyed by the bank stocks.

The Rs 2.11 trillion bank recapitalization through bonds, public money and equity are likely to push lending which has dropped to multi years’ low and there is a Rs 9 trillion push for the infrastructure mainly, roads, that might revive the slow private and public capex, both, which might instigate multiplier effect on investment, employment, demand and growth of the economy.

The measures taken by the government were due due to falling growth and growth expectation in the preceding several quarters mostly owing to rising NPAs of the commercial banks and the corporate also due to excess capacity of firms and low demand in the economy.

Both, recapitalisation and push for infrastructure are crucial for investment, employment and demand since infrastructure consumes unskilled labour and is labour intensive too.

INDIA has a vast unskilled labour force which is mostly consumed by agriculture and construction that employ more people than other sectors, however, construction has been saddled with loads of NPAs which is worrisome because it creates a lot of employment and is one of the engines of growth.  

The excess capacity and low demand in the economy reinforce low price and price expectations in the economy as case with the economy, nevertheless if the lower prices are passed on to the consumers by different sectors it would help increase demand in the economy. For example, INDIA has an excess capacity in the real estate and if the suppliers lower prices it might help achieve market share, demand and growth.

Banks, apart from sick PSBs, oil, cement and real estate are among industries that have excess capacity which might be used to increase demand in the economy if they reduce their prices.

INDIA has a huge population and demand, but income levels are low, notwithstanding if we try to increase real wages/incomes by keeping the prices low it would also help increase market share and demand and the economic growth rate.  

However, the lower level of investment and competition might affect the outcome.

More on GST, DeMo...

The government points that GST is being charged on value addition and is kind of VAT, but the question arises that then why we need five-rates, including the zero (?)...

If two business firms generate same kind of revenue in nominal money terms on the value addition per unit or per rupee, they should be taxed at the same rate...

However, it would simplify the procedure... We do not need five rates...GST should target profits on the value addition on goods and services...

There might be only two GST rates 0 and 12%...

Firms having higher profits would pay higher in nominal money terms... we do not need higher taxes on higher profits and value addition...

A single and lower rate would incentivize value addition in goods and services which means more employment and demand and growth and better compliance...

The GST should promote more and more value addition in the economy...

Moreover, demonetisation to digitalsation were not a hit on all the black money, everybody knew people would not give up easily, black money in cash was just the tip of the ice-berg... But, was a blow to the generation of black money...

It was a signal that the government won’t tolerate corruption and black money and the move was to end generation of the black money...

The government showed that it would not deter take strict action if it is in the favour of image of the government and of the common-man despite criticism... which showed results in the UP elections...

Demand would not pick unless...

It is a known fact that capital and investment might move to profitable locations in case of higher taxes and in a globalised world production might too get shifted to lower wage locations.

Nonetheless, lower taxes might increase capital inflows and appreciate the dollar which would also reduce the domestic and international price level by lowering taxes and the borrowing cost and would increase real wages and demand.

Higher savings due to higher real wages and higher real interest rate would reduce nominal interest rate and interest rate expectations, probably to zero.

Lower prices, lower interest rate and a strong exchange rate are also expansionary interms of domestic demand and imports/exports.

A strong exchange rate and lower import prices could also make the economy competitive and increase real wages and demand.

Assembling of low price imports into furnished exports has increased the Chinese competitiveness.

A strong currency also means cheaper imports and lower inflation and wage expectations and increased competitiveness.

However, it has been a tradition in economics to incentivize supply by lowering the borrowing cost and real wages which has backfired in terms of demand, there is little incentive to save and invest due to lower real interest rate and consume too because real wages have been cut below productivity.

If the transmission of lower cost to lower price and higher real wages don’t happen demand and growth would not pick…

Competitiveness and Growth...

Higher borrowing cost is making the INDIAn industry uncompetitive... New private domestic investment is not picking up...

Despite its cheap pool of labour INDIA has failed due to higher real rates compared to competitors...

FDI is flowing in, but the RBI has kept domestic demand under-check due to higher inflation expectations...

If foreign investment is allowed why higher real rates should bind domestic investment which could lose market share to foreign investment due to increased costs...

Higher rates have discouraged domestic private investment and growth and fresh demand for loans and business for banks...

The real fight is to invest more and more in education, skills and innovation to increase productivity, lower the price-level and increase competitiveness and demand...

However, inflation and depreciation may be short-term measures to increase investment, employment and growth by increasing external demand, but lowering domestic demand and imports'' demand, which in a way is contractionary by increasing interest rate and wage expectations.

Nonetheless, higher productivity and lower prices increase domestic demand and demand for exports and imports too because it would increase real wages and lower interest rate and expectations because it would also increase savings and investment and employment and growth...

Recently automation has aroused much curiosity and put as a dampener to employment, but it could increase labour supply which could require skill development to boost employment and growth...

Moreover, real wages would also increase due to increase in skills and productivity and lower prices and increase demand and growth...

Lower price and price expectations due to lower borrowing cost and unemployment and increased supply...

Inflation increases when demand or real wages or incomes increase and/or supply goes down, therefore to achieve the same prices should go down first and real wages or incomes increase which would decrease supply relative to demand and increase the price-level.

Higher demand and/or low supply expectations would increase inflation and inflation expectation. On the contrary targeting higher inflation and inflation expectation only due to increase in money supply and less focus on lowering inflation by increasing productivity and increasing real wages or incomes would increase only supply pushing economies in deflation and liquidity-trap by reducing spending.

In a bid to achieve exports and growth the Western countries have cut down on real interest and savings and real wages and incomes and consumption and demand by inflation and depreciation which has increased external demand at the cost of internal demand when countries like INDIA fared well by concentrating on the domestic demand.

When all countries do this at the same time global real wages or incomes and demand go down for all. However, if all countries try to increase their domestic real wages or incomes it would also increase demand for imports and exports. The global growth would go up.

Inflation and inflation expectations reduce spending because people would spend less and save more. Nonetheless, lower price and price expectations due to increased productivity and full employment and higher real wages would increase demand, consumption and (savings)/investment, or spending and the growth-rate...

Reforms and Rupee...

The consumption spending due to improved income expectations higher minimum wages, pledge to double farmers'' income and the 7th Pay Commission is likely to drive the economy despite of low business and government spending which would speed recovery in employment and growth... Lower wages and ample stock of labour and lower interest rate and expectations also increase probability of investment spending expectations followed by the consumption spending... Lower inflation would also lower cost and increase competitiveness... However, the RBI is expecting higher inflation on the basis of past experiences, but the government has worked well on the supply side reforms except land and labour reforms... The land reform requires lease reforms and life-long stream of incomes to the farmers or the land holders... However, labour reforms requires flexibility in hiring and firing which is important for the ease of doing business for which unemployment benefits or a good social safety net is required... Nonetheless, Insolvency and Bankruptcy Code is another milestone in timely recovery of loans and would help businesses and banks... The government role is to bring the schemes proposed in the budget to life by implementing them on the ground...

Recently the IMF has advised the Government to provide Rs 2600 Universal Basic Income (UBI) to all which would cost 3% of GDP after replacing food and fuel subsidy… However, a targeted transfer to the poor would reduce the cost... If there is a family of four, payment to parents only would suffice the objective... However, benefit to acquire knowledge and skills should also be transferred... NREGA is used as a tool to provide employment to the unskilled, but skill-development could reduce fiscal deficit by enabling them to get employment in the private sector, saving public money... It would reduce government expenditure on creating employment... Moreover, skills would also help increase real wages by increasing productivity... Demand and growth would increase…

A higher real effective exchange rate for the rupee or a strong currency means it could buy more things and foreign currency which could also make it competitive... It also means cheaper imports and lower demand and inflation... It also increases foreign currency inflows... A strong currency also increases competitiveness because INDIAn rupee could buy more... Whoever is holding the rupee would get benefited... Demand for INDIAn products could go up too... It would increase imports and exports too because real effective wages would go up due to lower domestic price-level... Recently exports have picked up despite a strong rupee...

Spending on skills, jobs...

Yesterday the RBI left-out all expectations of rate cut in the view of falling growth and growth expectations due to low demand in the economy, both investment and consumption are held back due to slow recovery in private demand owing to higher inflation, higher interest during UPA, and, rising NPAs of firms and banks and the lingering effects of reforms such as demonetisation and GST, during NDA. However, low growth rate due to reforms was widely expected and the economy is likely to bounce back after the September quarter as the effects of DeMo and GST would fade away and as long as we have low growth and growth expectation the RBI may have helped the economy to bounce back quickly by cutting on the lending rates, real rates in INDIA are much higher than targeted by our former RBI Guv Raghuram Rajan who started inflation targeting. But, to achieve the 8% and over growth the economy must sway away the problem of bad loans and demand with proper incentives from the RBI and government in the form of higher liquidity and lower interest rates and supply side measures to keep inflation under the target. Nonetheless, public spending on improving the supply side, especially the food which has had been a major cause of inflation in the modern INDIA could help lower interest rate and further strengthen the supply-side in the country. More spending on the food and agriculture economy which is a source of income to 60% of the population would help make the economy strong. Moreover, the government has also committed to double farmers income who face vagaries of all kind including weather and lack of irrigation facilities and floods, too. Even though, the government has a lot of spending schemes on the rural INDIA in the pipeline they should be implemented on the ground level, from the point of view of votes and constituency villages that inhabit 80% of the INDIA’s population may also prove helpful. A very large part of the workforce is in the villages and is employed in the unorganized sector which are hit by demonetization and less money-supply and GST and low supply of goods and services and creating employment for this unskilled pool of labour, partly dependent on NREGA and agriculture, for livelihood is important to revive demand in the economy and without massive industrialization of the economy it is really difficult to provide employment to all. The government instead of only creating jobs through NREGA might look further to employ them in industry by providing education and skills according to the industry demand. By providing employment the government could reduce poverty much faster than doling out freebies, the government should directly transfer funds for education and skill development through the DBT. Education and training of skills and job are the best antidotes to hunger, malnutrition and poverty. The huge demographic dividend which is at the base of INDIA’s growth story and optimism would be simply lost if the country falls on education and skills levels behind other countries… 

Local spending, jobs and the economic growth...

Even though the government at the Center has succeeded in preserving the macro-economic indicators such as fiscal deficit, current account deficit and inflation it has still a lot more to do on employment, demand and growth, when private investment are shying away from more investment and employment due to slow recovery in growth contingent on NPAs and bad loans which are holding new investment and loans back. However, slow private investment has given rise to the clamour for more government spending, but devolution of more funds to the states as a result of the decentralisation has left the Center with few options and less resources to increase public spending to invigour private demand, consumption and investment, nonetheless the center might still invoke local public spending by the states to increase wages or incomes for more demand in the economy, the government might force the state governments to increase their expenditure outlay on increasing productivity, infrastructure and employment which could increase both the demand and supply or the economic activity and growth… The local governments have, now, more capacity to spend when a larger part of funds are now with them and they might play a constructive role in increasing demand in the overall economy… The full employment is very important for the full demand and growth rate… The government might push the local governments to create more employment and growth in their localities…

Services equally have potential to create jobs for the workforce and workforce that join the mainstream everyyear... By lowering the service tax the government might further incentivize job creation... Nonetheless, INDIA has a comparative advantage in labour intensive line of production because labour is in plenty and cheap, real effective wages are low... Moreover, real effective interest rate is higher in INDIA which makes capital dear... Even normally, capital intensive techniques are costlier than labour intensive techniques... Therefore, to provide gainful employment to its workforce INDIA should specialize in labour or services intensive techniques in order to achieve competitiveness and demand and growth...