New Delhi: Growing inflationary pressures have made it imperative that the government announce a clear timetable for an “exit strategy” from the stimulus measures introduced since last year to revive growth, the Prime Minister’s economic advisory council (EAC) said on Wednesday.
Failing to do so in an economy flush with liquidity could unleash fresh macroeconomic challenges that could roil the economic recovery under way, it said.
Underlining the urgency, EAC noted that the economy is on the path of recovery and would expand by 6.5% during the current fiscal on the back of a strong rebound in industrial growth. This could, however, be derailed if the global economy was to undergo any fresh economic shocks.
“The economy may grow in the range of 6.25-6.75% in the current fiscal,” said C. Rangarajan, EAC chairman, while releasing its Economic Outlook for 2009/10. “However, our best estimate at this moment is 6.5%.”
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Manufacturing output, which bounced back in June after remaining sluggish since November 2007, is expected to recover in the second half of the current fiscal to grow at more than 9% and thus average around 7.7% in 2009-10.
“Though export demand is yet to pick up, the recovery in manufacturing output is broad-based and strong enough to suggest a recovery based on domestic demand, improved business confidence and a stable operating environment,” the report said.
On the exports front, the council said though the outlook is not favourable to expansion, it expects “strong growth” in the second half of 2009-10, with the value of exports for the current fiscal reaching $189 billion (Rs8.7 trillion) against $175 billion in 2008-09.
However, in the short term, managing inflation, particularly food price inflation due to a drought in most parts of the country, is going to be the biggest challenge for the government. The council expects Wholesale Price Inflation to cross 6% by March 2010, higher than the projection of 5% by Reserve Bank of India (RBI) by the same time period.
The council has said the government needs to strengthen the public distribution system combined with some open-market sale of public stocks so as to contain price pressures. It has also advocated that the concerned agencies should be instructed to facilitate the import of rice if required.
The council cautioned that in the absence of a time-bound exit strategy, price pressures can jeopardize a steady economic recovery. The additional stimulus announced by the government since October 2008 aggregated Rs1.86 trillion, finance minister Pranab Mukherjee disclosed in an interview to Lok Sabha Television on 6 July, immediately after presenting the Union Budget for 2009-10.
In the same period, RBI in its April credit policy statement said the “potential liquidity” from the monetary measures was Rs4.22 trillion.
“A convincing strategy that is unambiguously spelt out and a clear timeframe for returning to more normal monetary and fiscal times are necessary to act as counterweights to rising inflationary pressures,” the report said. “The very open monetary and fiscal stance adopted to mitigate the effects of the crisis today represents a tangible reason for inflation and inflationary expectations to be much higher than over the past two decades.”
However, the council said that the timing and the pace of the exit strategy will depend on the pace of expansion of the various sectors and the magnitude of inflationary pressures.
“Since it would not be possible to bring down the expansionary fiscal policy in a major way before March 2010, fiscal consolidation needs to start from next year,” Rangarajan said.
However, agreeing with the view of RBI governor D. Subbarao, the report said the government may have to act earlier than the US and European economies, given the present inflationary pressures.
The government think tank believes the fiscal deficit could be narrowed by 1.5% of gross domestic product in the next fiscal if the expenditure on various schemes is kept constant in nominal terms while liability on account of pay revisions and farm loan waivers would be considerably lower in 2010-11.
For the current financial year, the consolidated fiscal deficit including liabilities of state governments is projected to be 10.09% compared with 8.6% a year earlier.
Joblessness outweighed concerns over inflation, said an expert.
“An exit strategy at this time will be premature because unemployment is still a huge problem,” said Jayati Ghosh, professor at New Delhi’s Jawaharlal Nehru University. “While the government can stop giving other stimulants, especially those designed to help the private sector, it needs to step up employment by giving concessions to the small-scale sector.”
RBI may move to shift its stance early next year, said N.R. Bhanumurthy, professor at the New Delhi-based National Institute of Public Finance and Policy.
“I feel that before March 2010, there might be a drive to tighten the monetary policy, maybe in January,” he said. “The council’s optimism may have been driven by a 78% rise in the index of industrial production in the last two-three months, but then the council is projecting a lower growth in services and a negative growth in agriculture. So these sectors need a boost along with infrastructure where capital expenditure is required.”
EAC also cautioned that crude oil prices may again soar as developed economies recover, adding to the existing inflationary pressure. While crude oil price is currently around $70 per barrel, the council has factored in a price of $75 per barrel, Rangarajan said.
The report said that apart from the unsustainable monetary and fiscal policy and high inflationary expectations, the international situation could act as a deterrent to a sharp recovery of the Indian economy.
“The other risk is the possibility of another setback to the world of finance, where even a small failure has an amplified capacity for destabilization,” it said.
Graphics by Ahmed Raza Khan / Mint