The crying need to bring inflation to heel should hopefully force finance minister Pranab Mukherjee to present a tight budget on 28 February. The Reserve Bank of India (RBI) has already been busy tightening its monetary policy by increasing interest rates seven times since March. This overdue withdrawal of monetary and fiscal stimulus could hurt growth in the short run. It needs to be balanced with a fresh reforms stimulus.
Here’s why. Almost exactly a year ago, the finance ministry ended the first chapter of its excellent Economic Survey on an optimistic note: “It is entirely possible for India to move into the rarefied domain of double-digit growth and even attempt to don the mantle of the fastest-growing economy in the world within the next four years.”
The optimism came at a time when India was being lauded for its quick rebound from the brutal global downturn. A lot has changed since then. Now the threat of double-digit inflation is a far more potent issue than the prospects of double-digit growth. Policy attention has dramatically swung from the latter to the former.
Demand management is thus the big topic of the day. The best way to control inflation in the short run is to compress private demand through higher interest rates and compress government demand through a lower fiscal deficit.
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Fair enough, but it is also time to get supply-side economics out of the freeze to ensure that higher aggregate demand is met by higher aggregate supply so that high growth is not necessarily inflationary. The forthcoming Union budget is a good time to indicate serious reformist intent, because India cannot have sustainable double-digit growth without a further dose of economic reforms.
Consider a few examples. The introduction of a goods and services tax (GST) will help create a single Indian market, reduce transaction costs, minimize distortions in the use of resources and provide manufacturing industries with a chance to build economies of scale. The GST will increase the size of India’s economy by between 0.9% and 1.7%, according to estimates. Reforms in the retail sector will help in the construction of nationwide cold chains that will link farmers and urban consumers far more efficiently than the current unorganized and undercapitalized distribution chains do. Modern retailers will help cut wastage of perishable farm commodities such as milk, fruit and vegetables. Insurance sector reforms can help create a long-term debt market that (among other things) provides finance to long-gestation infrastructure projects, which are currently being financed by banks through their short-term liabilities.
Such reforms have been on the agenda for at least five years, if not more. Through sheer inaction, the United Progressive Alliance (UPA) has done precious little to increase the economy’s capabilities since 2004. This is one reason why the output gap closes very early in the business cycle and high inflation erupts whenever the Indian economy grows at more than 8.5% for a few quarters. The lack of attention to farm productivity is already translating into higher prices for many foodstuffs. True, we also have the problem of imported commodity inflation. But structural impediments—the endogenous speed breakers—also deserve policy attention.
The UPA seems to have assumed that growth is on autopilot and benign neglect can, therefore, be the moving spirit of economic policy. This is dangerously myopic, though the costs of such inaction are not immediately obvious. A splendid 10 percentage points increase in savings and investment rates since the turn of the century provides a structural floor to our growth rate and ensure that we will grow faster than most other major economies, or perhaps grow faster than China as well as it moves closer to the global productivity frontier and ages as well.
Yet, the current growth trajectory can be bettered—and needs to be bettered. The damage of flying below true potential will not be evident over a short period, but will be quite evident over the long term thanks to the power of compounding.
Consider this scenario. India keeps growing at an average of 8% a year over the next 20 years without a concerted attempt at further economic reforms. Our current per capita income of around $1,200 will grow to $5,593 by 2030 (assuming for the sake of convenience that population growth is nil). Now consider what could happen if economic reforms lift the long-term growth rate to the elusive 10%. Per capita income in 2030 will be $8,073! The true cost of policy inertia suddenly becomes evident. The cost of lower growth over two decades will show itself in higher poverty, unemployment and most indicators of human welfare.
Economic reforms have fallen off the map. They need to be brought back into the spotlight for the sake of the average Indian, whose opportunities for a better life will move up in sync with higher economic growth.
Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at firstname.lastname@example.org