A day after Prime Minister Manmohan Singh re-emphasized the need for higher growth, the Reserve Bank of India (RBI) on Friday raised red flags on virtually every economic indicator of significance and consequence. “Decline in domestic growth coupled with relatively high inflation, fall in domestic savings, particularly household financial savings, fall in investment demand and moderation in consumption have increased the risks to macroeconomic stability,” the central bank noted in its Financial Stability Report. Further, RBI, in addition to stressed position on fiscal and the current account, also highlighted concerns on falling profitability and rising stress in the banking system.
Apart from the usual suspects and the high fiscal deficit, there are two major issues that need attention. Both pose significant medium-term challenges to economic management, though their source, again, can be tracked to the reckless government expenditure.
First, the quality of foreign inflows that India has been forced to rely on depends on the magnitude of its current account deficit. Even as the external debt continues to rise, the volatile capital flows are now worth 81.3% of the total reserve, while the reserve itself has fallen to 82.9% of total external debt compared with 99.6% in March 2011. Therefore, external financing and currency can pose serious challenges to economic stability in case of rise in volatility in the global financial market.
Second, the financial savings of the household sector have fallen to a two-decade low to 7.8% of the gross domestic product, is a source of worry. Households, rationally, under pressures of high inflation and low-to-negative real returns in the financial assets, have shifted to other assets such as gold and real estate, that are perceived to be inflation-proof. This shift is a clear warning, and those batting for lower interest rates in the economy, including the government of India, need to approach the issue more holistically. Interest rate also has a savers angle, which is often forgotten, and just cutting interest rates will not bring back growth out of thin air. It is inappropriate to put the burden of bringing growth back on the households and push them out of the financial system—a loss-loss situation.
Fundamentally, the drivers of the Indian economy have lost track. Growth and stability, as argued in this space before, will only return when the government gets its act together.
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