Contraction and Demand

Many institutions had     assessed in June that India's economy will suffer a contraction of five percent. Now the same institutions are saying that the economy will suffer a contraction of ten percent. This contraction is likely to get worse in the coming months because the Corona Pandemic is showing no signs of abating. One may face a second wave in the winter months if the experience of resurgence of the Pandemic in Europe is any guide. In this gloomy scenario, the Government is mighty pleased that a huge 75 percent increase in sales of tractors, about 18 percent increase in the sales of cars and 12 percent increase in the sales of motorcycles has taken place in September 2020 as compared to the same month in the previous year. Question is this: how come the purchase of tractors and cars is increasing when the GDP is contracting? In truth farmers are making "distress" purchases of tractors due to the shortage. Similarly, the unavailability of public transport like bus, metro and local trains have pushed commuters to make distress purchases of cars and motorcycles. These purchases should not be misconstrued as indicators of revival of the economy.

The Government, however, is aware of the contraction of GDP. It has encouraged banks to give loans to consumers and businesspersons aggressively to generate demand in the market. There is a basic difference in the loans taken by businesspersons and consumers. Loans taken by investors are used for setting up factories, establishing shops or buying trucks. The businessperson and the nation generate additional income from these investments; and she could pay the interest and repay the principal amount from that additional income. The second method of increasing demand in the market is for the Government to borrow and transfer some amount directly in the bank accounts of the people who can use this windfall to buy goods from the market. However, the Government will have to repay the loan and for this purpose it will have to impose additional taxes or print notes. The imposition of these additional taxes will lead to reduction in income in hands of the people and to lower demand in the next year. Printing of notes will lead to an increase in the prices and again lead to reduced demand in the next year. These are, therefore, band-aid type of temporary fixes that will only push the economy deeper into the pit.

The third method of raising money for making the direct transfers is for the Government to increase import duties. The share of import taxes in the revenues of the Government has declined from 18 percent about six years ago to 12 percent today. The Government has actively promoted imports by reducing import duties. India has committed in the World Trade Organisation (WTO) that the average import duties won't be increased beyond 48 percent. The actual rate today is less than 20 percent. Therefore, there is a roadblock from the WTO in doubling the import duties. The Government can increase the import duties, say, from present average 20 to 40 percent. The Government was obtaining revenue of 170 lakh crore from import duties in a year till recently. Doubling of the import duties would lead to a reduction in the imports hence the revenue raised will be less than double. A caveat is necessary here. India had high rates of import duties before the economic reforms were unleashed in 1991. That had not led to increase in domestic production before 1991. One may ask how, then, will the imposition of high import duties lead to increase in domestic production now? The difference today is that here businesspersons have since been exposed to the international market and have acquired the capacity to produce goods of international standards.

The Corona Pandemic is here to stay for some time. Short term fixes like disbursals of loans will not help in this situation. But the Government's hands are tied. The only solution is to make a huge increase in import taxes and simultaneously implement policies that encourage business persons to adopt advanced technologies and make good quality goods at low cost.

Vol. 53, No. 26, Dec 28 2020 - Jan 2 2021