An Absence of Euphoria

Summary
The problem:

 Sharp fall in nominal growth has impacted the Indian economy negatively
 GDP growth is driven more my cost control rather than revenue growth
 India is more vulnerable to growth shocks, a GDP slowdown is likely
 Risk taking/ animal spirits are dampened, and will impact private investments
 There is a hidden loss of potential tax revenue
 Current slowdown in GDP growth was predicted by me based on above reasons in January
2019. Situation will continue if steps are not taken with some urgency.

Remedial steps:

Budget should focus on re-kindling euphoria in the economy. Take steps including, but not limited
to:

 Remove Long Term Capital Gain Taxes

 Remove Dividend Taxes
 Encourage RBI to cut rates at a faster pace
 Induce some asset inflation (through real estate)
 Tap foreign sources of finance to augment liquidity in the system
 Consider introducing Nominal GDP targeting in parallel with the Inflation targeting mandate
of the RBI

Suboptimal GDP mix (between growth and inflation)

Real GDP growth comes from two sources, the nominal growth (based on current prices) and the
GDP deflator (loosely, the inflation rate).

Over the past few years, more of the Real GDP growth has come from control of inflation rather than
nominal growth. This is evident from the closing of the gap between the Real and the Nominal
Growth.

While, control of inflation to benign levels (which do not pinch the aam aadmi, but are high enough
to encourage investment/ risk taking) is a positive, the sharp deceleration in nominal growth has
sapped the enthusiasm from Indian risk-takers.

Anirudha V Limaye (anirudha14@gmail.com) – June 17, 2019 Page 1

 An Absence of Euphoria

India growth vulnerable to shocks

The chart below is the difference between Nominal GDP Cagr and Real GDP Cagr for four year
chunks, and it asks the question, how much more Real GDP growth can we squeeze out of inflation
control when the gap has narrowed precipitously?! If we agree that the FY06 to FY09 period was
when UPA 1 was still benefiting from the steps taken by the NDA 1 government, even then the gap
was 8%+

This narrow a gap also renders us vulnerable to a systemic shock. Imagine if inflation rises 2ppt, i.e.
from 2-3% to 4-5%. As a number an inflation of 4-5% is not worryingly high. But because of the
reduced Nominal growth it will have a disproportionate impact on the Real GDP growth numbers.
This will have both economic and political repercussions.

Dampening effect on ‘animal spirits’

The fall in nominal growth has a psychological/ behavioral impact. A person perceives the world in
the ‘nominal’ and not the ‘real’. He targets revenues and budgets costs in the ‘nominal’. Rising
purchasing power is not as obvious an impact for him.

In fact in an era of slowing revenue growth (as falling Nominal GDP would suggest), rising purchasing
power may have a negative impact. Why would a person spend today, when he can spend tomorrow
and get more? Why spend tomorrow, when he can wait for a month and get even more utility from
his savings?

Anirudha V Limaye (anirudha14@gmail.com) – June 17, 2019 Page 2

 An Absence of Euphoria
It is for this reason that most of the GFCF is coming from the public sector, while private sector
capacity utilization remains well below the peak. A large part of the credit growth is also on account
of working capital financing rather than long term investments.

This is a vicious that will lead to sharp slowdown in corporate revenues, profits, and employment.
Already for FY18 the corporate profit as % of GDP is near all-time lows of 2.8% (per some
estimates). And if the employer is not making money, then the employees are not getting their
salary increments and bonuses, transmitting the economic melancholy down the line. This is the
worst kind of trickle-down economics.

Hidden loss of potential tax revenue

GST has tightly linked government revenues with revenue growth, i.e. nominal growth. The falling
nominal GDP is, I believe, likely causing a tremendous hidden loss of potential revenue to the
exchequer. The current increments in the monthly GDP collection are likely coming from informal
businesses registering themselves or losing business (and jobs) to the formal sector. However, with a
slowdown in nominal growth, the pace of these incremental tax collections will slow down.

Remedial steps
Objective is to keep inflation at benign levels, while keeping enough nominal growth that will
encourage risk-taking and allow entrepreneurs to plan their long term investments. Objective of the
budget should be to induce a feel good factor among the public, make people euphoric. A man
spends when he is happy, and is happy when he spends.

My intent is framing this note is to suggest the root cause of the problem, that perhaps may have
been missed. It is worth noting that I had highlighted this via my blog
(http://ecopoliticalindia.blogspot.com/2019/01/the-crux-of-core-on-inflation-exchange.html) in
January, and predicted the slowdown of GDP growth, that is now coming to pass.

While I leave the remedial steps for experts in the government to decide, some suggestions to
induce euphoria are:

 Remove Long Term Capital Gain Taxes

 Remove Dividend Taxes
 Encourage RBI to cut rates at a faster pace
 Induce some asset inflation (through real estate)
 Tap foreign sources of finance to augment liquidity in the system
 Consider introducing Nominal GDP targeting in parallel with the Inflation targeting mandate
of the RBI

Anirudha V Limaye (anirudha14@gmail.com) – June 17, 2019 Page 3