any institutions had assessed in June that our economy will suffer a contraction of five per cent. Now the same institutions are saying that the contraction will be of ten per cent. This is likely to get worse in the coming months because the corona pandemic is showing no sign of abating. We 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 per cent increase in sale of tractors, about 18 per cent increase in the sale of cars and 12 per cent increase in the sale of motorcycles has taken place in September 2020 as compared to the same month the previous year. Question is this: how come the purchase of tractors and cars is increasing when the GDP is contracting? My assessment is that farmers are making ‘distress’ purchases of tractors due to the shortage of labour caused by the failure of the government to encourage migrant workers back to their host states. Similarly, the unavailability of public transport like bus, metro and local trains have pushed commuters to make distress purchases of cars and motorcycles. Owning a vehicle helps in safe travel in Covid times. So, these purchases should not be misconstrued as indicators of a 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 he could pay the interest and repay the principal amount from that additional income. Say, a businessperson took a loan of `10 lakh, earned an additional income of `3 lakh and used this to repay the interest of `1 lakh and principal of `1 lakh; and he may still have with him `1 lakh for making new investment in the next year. His total expenditure will increase from `10 lakh this year to `11 lakh the next year.
The situation of a consumer stands on an entirely different footing because he is not likely to obtain any additional income from buying, say, a fridge. Say, he took a loan of `10 lakh. He would have to pay an interest of `1 lakh and principal of `1 lakh and will be left with `2 lakh less for making new purchases in the next year. His expenditure will decrease from `10 lakh this year to `8 lakh next year. The income of the common man is already under stress. They should not invite further decrease in the same by take a consumption loan.
The economy may show some immediate benefits from disbursal of such loans just as steroids help increase the milk yield in cows immediately but this will only lead to problems later.
The second method of increasing demand in the market is for the government to borrow and transfer some amount directly to 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 a reduction in income in hands of the people and lower demand the next year. Printing of notes will lead to an increase in the prices and again lead to reduced demand 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 per cent about six years ago to 12 per cent today. The government has actively promoted imports by reducing import duties. Note that we have committed in the World Trade Organisation (WTO) that we will not increase the average import duties beyond 48 per cent. The actual rate today is less than 20 per cent. Therefore, we face no roadblock from the WTO in doubling the import duties. The government can increase the import duties, say, from present average 20 to 40 per cent.
The government was obtaining revenue of `170 lakh crore from import duties a year till recently. Doubling of the import duties would lead to a reduction in imports, hence the revenue raised will be less than double. I reckon the additional revenue generated will be about `150 lakh crore. This money can be used to transfer `1,100 per year in the bank accounts of the 135 crore citizens or `5,500 per family per year. People can buy goods in the market from this money. Such a payment will not lead to additional burden of interest in the ensuing years. It will also not lead to increase in supply of printed notes and inflation.
Indeed, there will be price rise in the imported goods. But even this may be short-lived until domestic production picks up to supply cheaper-than-imported goods. The benefit of this approach will be that imported goods will become expensive, domestic goods will become cheaper in comparison, domestic industries will revive and employment will be generated. The income earned by workers will establish a fortuitous cycle of demand generation and income.
A caveat is necessary here. We 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 our businesspersons have since been exposed to the international market and have acquired the capacity to produce goods of international standards.
The pandemic is here to stay for some time. Short-term fixes like disbursals of loans will not help. 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 businesspersons to adopt advanced technologies and make good quality goods at low cost.
The writer is a former Professor of Economics at IIM Bangalore.