SUMMARY
Economic growth declined sharply across the globe following the trans-Atlantic financial crisis of 2008-09.
Despite what is arguably the greatest growth potential amongst major economies in the world, the Indian economy is stuttering. After a recovery to 8.6 per cent in 2009-10 and 8.9 per cent in 2010-11 after the global meltdown of 2007-08, India’s growth rate declined almost continuously over several successive quarters from Q1 2010-11 to Q1 2012-13. As a result, annual economic growth moderated significantly to 6.7 per cent in 2011-12, 4.5 per cent in 2012-13 and is estimated to be below 5 per cent in 2013-14.
Economic growth declined sharply across the globe following the trans-Atlantic financial crisis of 2008-09. Growth in emerging markets (EMs) still overly dependent on final consumer demand in advanced economies has also declined sharply. India was expected to weather the storm better than its EM peers because of its greater reliance on domestic demand. Over the last three years, the decline in Indian growth has, however, been steeper than in several major Asian EM peers, including China and Indonesia, and indeed emerging Asia taken together. Except China, the BRICS are no doubt growing slower than India, but Indian growth trends need to be assessed by Asian standards. Domestic factors seem to have played a large role in the decline in growth.
The downturn is not simply cyclical. Macroeconomic stabilisation policies — monetary and fiscal — can therefore play only a limited role in remedying the current stagflationary mix of low growth and high inflation. Fiscal and monetary tightening to target inflation would further reduce growth at this juncture. Monetary policy is also a blunt tool for targeting inflation emanating from supply side constraints in agriculture. On the other hand, monetary and fiscal stimulus to target low growth will only add to inflationary pressures, without ramping up supply in the short run.
Recent incremental capital output ratios indicated that it was nevertheless possible to accelerate growth over the short run. This is because the decline in growth was much sharper than the decline in investment, pointing to a decline in the productivity of capital rather than in growth potential. A number of measures to stabilise growth by de-bottlenecking projects under execution and accelerating new projects in the pipeline were consequently put in place over the last 18 months, but they have yet to yield the expected outcome.
Although the decline in growth seems to have bottomed out since the second quarter of 2012-13, manufacturing, exports and new investment remain flat. Current data on lead indicators such as purchase of vehicles, consumer durables and housing also suggest that the recovery is far from certain. There is also a sharp decline in the pipeline of fresh projects that underpin medium-term growth. The overall investment sentiment remains weak and macroeconomic imbalances (the twin current account and fiscal deficits, and a continuing demand-supply gap reflected in high inflation) continue to be high by EM standards. Recent declines in the CAD and inflation are more a reflection of the sharp decline in growth rather than a return to a virtuous cycle of robust growth and macroeconomic balance.
India’s economic potential deriving from rising savings, declining poverty, a big and growing middle class and good demographics continues to be good. According to the IMF’s World Economic Outlook of April 2014, India has the potential to overtake China’s growth rate within five years. To realise this, however, confidence-boosting political signals are needed to turn around investor sentiment. Beyond this, key challenges emanating from current macroeconomic and structural imbalances and institutional weakness need to be addressed to put the economy back on a sustainable high-growth trajectory.
Market expectations from a new executive frequently lead to bull runs that can revive animal spirits essential to re-ignite the investment-growth cycle. But these sentiments can be sustained only through credible signals from the new government of a strong commitment to address the sticky issues that had adversely impacted investor sentiment in the first place. This would, inter alia, mean major reforms in policies on land, labour and agriculture, which have been largely untouched by economic reforms since the 1990s. These reforms should be seen to be done within an overall institutional framework of free markets, simple, easy to enforce rules, transparent governance and policy coherence. The overall objective should be to create opportunities for investment, employment and personal income growth rather than simply redistributing incomes through tax transfers and subsidies.
Specific policy thrusts in four broad areas that target the current structural weaknesses of the Indian economy are also required. First, an investor-friendly policy environment needs to be created, which is conducive to private investment in labour-intensive manufacturing and physical infrastructure. This would address the CAD, create employment and improve the productivity of physical and human capital. Second, reform of agricultural markets would strike the inflation problem at its root. Third, fiscal restructuring should improve tax buoyancy and redirect public expenditure from untargeted non-merit subsidies to public infrastructure, while keeping the overall deficit within prudent limits. Fourth, governance and policy coherence can be improved through effective enforcement of a limited number of simple, non- discretionary rules, and by conflating the large number of government departments that have fragmented policymaking over the years into about 15 ministries
Consensus on bold policy initiatives in a challenging political environment can be made easier by taking states into confidence and giving them the policy space to adapt and implement what is acceptable to their civil societies. Policy convergence is more likely through the demonstration effect from implementation and outcomes in other states, than through a top-down approach.
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