BackMid-year review: Macroeconomic policy rethink required
The critical issue is of navigating the way out of the trap of macroeconomic policies that the Indian economy is currently embedded in
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The mid-year review of the economy released last week turns the focus towards rethinking macroeconomic policy support to revive the economic cycle. Economic conditions, according to the review, are quite weak, even as it records the exceptional role of public investment and private consumption in driving this year’s recovery along with numerous successes, such as lower inflation and improvements in public finances and external balances. This is the singular message it conveys, notwithstanding the backdrop of elevated growth rates depicted by the new series of national accounts, the mysteries of which it explains at some length. The focus of the review appears to be upon how to break out of the circle of excess capacity, weak demand, falling prices, high levels of debt and much else.
This context, which translates into a sizeable output gap, leads to the argument for reappraising macroeconomic policies, both fiscal and monetary. The questioning of procyclical policies – fiscal policy has been contractionary since the second half of 2012 and monetary policy in tight mode from 2010, followed by a further tightening in 2013-14 with a structural shift towards a consumer price inflation target – is in the right direction and welcome. Indeed, it arguably comes quite late in the cycle, when much water has flown under the bridge. How else does one view the steady worsening of corporate balance sheets, the continuous increase in interest costs, the relentless souring of bank loans and the structural deterioration of banks’ balance sheets as result, except as the stark, visible output costs of over tight monetary policy?
Combined with fiscal consolidation, which was undeniably required, the overall macroeconomic policy stance of past three years quite accounts for the current economic situation in the adverse demand environment at home and overseas. It is remarkable how most analyses of India’s ‘true’ economic conditions continue to overlook these aspects. It is refreshing that the mid-year review breaks out of the prevailing discourse and directs attention instead towards policy support, which is considered the need of the hour. Conceding the absence of exports and private investment support in the forthcoming period, the question asked is what can propel the recovery cycle given a pre-committed fiscal consolidation path, now even more squeezed by falling nominal gross domestic product growth, and consumer demand that remains tentative?
The critical issue here is of navigating the way out of the trap of macroeconomic policies that the Indian economy is currently embedded in. On the monetary side is the inflation targeting framework, newly signed and endorsed by the government. A flexible interpretation of the inflation goal, or a more gradual glide path that the review talks of, invokes credibility issues even if the central bank were to agree to such a deviation. Credibility issues on the fiscal side are far more serious in the light of India’s history and the increased dependence upon short-term foreign capital. Then, assuming these obstacles were surmountable, what if inflation was to potentially shoot up, beyond 6% – the review suggests that the sizeable output gap eliminates such a risk – accompanying the relaxation of fiscal targets? Would the theme of ‘fiscal dominance’ and inflation return to haunt India? These policy boundaries require deft handling if the course suggested in the review is to be pursued in the next step.
Renu Kohli is a New Delhi based macroeconomist.
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