BackA crash course in crisis economics
Here are five reasons that explain how India lost its way.
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The weakening Indian rupee is spreading nervousness all around. The falling economic growth is another area of worry. The growth in gross domestic product (GDP) in the first quarter of the current fiscal slipped to a low of 4.4%. Clearly, the Indian economy is looking more vulnerable today than any time in the recent history. However, it was not long ago when India was regarded as one of the most promising economies in the world.
So what went wrong? Here are five reasons that explain how India lost its way.
The fiscal imbalance
The Indian economy was possibly at its strongest at the end of financial year 2007-08 (FY08). It had registered at least 9% growth for the third consecutive year with modest inflation. Government finances were also under control with gross fiscal deficit of the central government at just 2.5% of the GDP. It was FY09 when the seeds of the present crisis were actually sown and India never really came out of it. With elections in mind, the government went into a spending spree. As a result, in FY09, the fiscal deficit jumped to 5.99% of the GDP. Although FY09 was also the year when the global economy was in a real bad shape, but the financial crisis was not the only reason why government finances in India went completely out of hand. Consider this: the government of India spent about 1.3 trillion on subsidies that year which was roughly double the amount budgeted in the beginning of the fiscal. The fiscal deficit has remained continuously above comfort levels ever since. Higher government spending resulted in higher demand, which did push growth for a while, but also led to persistent high inflation and higher current account deficit (CAD).
Missing drivers of growth
As India suffered from very high levels of inflation for at least three years to 2012, it was repeatedly argued by economists, opinion makers and the central bank that we need to clear supply side bottlenecks to sustain growth, but nothing much was done about it. On the contrary, the government was only seen firefighting one political crisis after another. In fact, due to a variety of reasons, such as those related to clearances, environment and graft, the business and economic environment only worsened over the years. In between there was Reserve Bank of India fighting a lonely battle against inflation by raising interest rates, which in turn affected demand and further dented the growth prospects. From the highs of 9.6% in FY07, the GDP growth in India slipped to its lowest in a decade at 5% in FY13.
The missed opportunity
India failed to take advantage of the accommodative monetary policy adopted by the US Federal Reserve. Even if excesses were built on the fiscal and the external front, there was ample time to take corrective measures. Nothing happened. It was only when the international credit rating agencies threatened with a ratings downgrade in the middle of 2012, measures were taken to cut fiscal deficit. However, by then, the damage was done. Now financing the current account became a major source of worry for India and CAD reached a high of 6.7% of the GDP in the third quarter of FY13. A balanced budget with moderate and controlled inflation would have certainly avoided such an outcome.
India was still able to finance a large CAD because of easy availability of money in the global financial system. But that was never supposed to last forever and as the signs of a reduction in global liquidity emerged, the rupee came under serious pressure.
Delayed adjustment
The present state of panic in the currency market could have been easily avoided. Normally, as CAD widens, the currency depreciates, which discourages imports and pushes exports. But this did not happen in India. Why? Because the government allowed Indian companies to borrow more in the international market and incoming dollars were used to pay the import bills. Consider this: the total foreign debt jumped from $306 billion at the end of FY11 to $390 billion at the end of FY13. Perhaps the idea was that while debt dollars will pay for the import bills for the time being, CAD will correct automatically. Again, this did not happen.
Lack of ownership
Despite numerous warning signs, the government of India never accepted that there were problems in the economy in recent years. Since it did not accept the problems, it never acted to correct them. Even now, for example, the onus of falling rupee is being shifted to the Federal Reserve. Yes, the reduction in bond buying by the US central bank was bound to have an impact on emerging markets, but this is something which was always known.
Federal Reserve is acting in the interest of the US. If we had a balanced budget today and a moderate CAD, policies of a foreign central bank would not have threatened our financial and economic stability. The problem of the Indian economy was always within and solutions were always in our hands. It’s just that we couldn’t get our act together in time.
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