Mumbai: The year 2012 saw important parts of the Indian policy establishment shed some of their hubris about the trajectory of the economy over the next few years. This was welcome, because recognizing a problem is often the first step towards solving it.
The change in attitude coincided with the departure of Pranab Mukherjee from the finance ministry. Manmohan Singh took charge of the key ministry for a little more than a month before handing it over to P. Chidambaram on the last day of July. The change of guard came at a time when investor confidence was fragile. The rupee had touched a record low of 57.14 to the dollar on 27 June, a day after the Prime Minister became the interim finance minister.
The initial focus was quite correctly on stabilizing investor expectations. The government said it would take a fresh look at two measures announced in the 2012 budget that had particularly rattled investors: retrospective taxation on corporate deals and the general anti-avoidance rules that its critics said gave too much power to the taxman.
Bolstering investor confidence was important as a first line of defence because India will need around $80 billion (around Rs.4.4 trillion today) of net foreign exchange inflows to fund its record current account deficit this year. The Reserve Bank of India (RBI) also went into action; it has cumulatively sold $2.15 billion to support the rupee since April, more than half of it in July and August, according to new data from its monthly bulletin.
These measures, as well as the announcement of more quantitative easing by Western central banks in September, saw the rupee stabilize, despite a decline in October and November. Foreign portfolio investors poured money into Indian equities; their cumulative purchases by 21 December were worth $23.17 billion.
But liquidity support alone was never going to be enough since the problems in the Indian economy are structural, something that this newspaper has been pointing out in its Views pages since 2009: slowing growth, a high fiscal deficit, persistent inflation and the collapse of corporate investment. The problems are too deep-rooted to be addressed with just another stimulus to demand, be it through more government spending or lower interest rates. The real problems lie on the supply side, which can be resolved only with structural reforms.
Thankfully, government agencies began coming around to this view. The committee headed by Vijay Kelkar did some welcome plain speaking. “India is on the edge of a fiscal precipice,” it warned in the very first sentence of its report. RBI said the potential growth rate of the Indian economy—or the growth that it can sustain without setting off high inflation—was now down to 7.5%, around one percentage point lower than what it was in the boom. Private sector economists argue that it may have come down even more, a fair assessment since India has signs of excess demand even when growth is around 5.5%.
In its mid-year review of the economy released in December, the finance ministry slashed its growth forecast for the current fiscal from 7.6% to between 5.7% and 5.9%. The Planning Commission seemed to give a more sunny prediction in its draft 12th Five-Year Plan (2012-17) released in the same month. It said India is likely to grow at an average 8.2% over these five years, but added something important to the document: scenario planning. The agency said the high growth rate would be achieved if the government delivered on various policy recommendations.
So it outlined two other scenarios. The second scenario assumed half-hearted action, when policies are endorsed but not acted upon. That would yield a growth rate of between 6% and 6.5%. The third scenario was of a policy logjam. Growth would then drift down to between 5% and 5.5%. Tracing three possible trajectories and linking them to progress on the policy front was a welcome exercise in realism.
That is why the recent burst of energy in the finance ministry under Chidambaram and Raghuram Rajan, his economic adviser, is welcome. There have been a lot of valid questions about whether what the government has done over the past few months actually amounts to structural reform. For example, is getting more foreign investment into organized retailing as important as finally getting the goods and services tax off the ground? Is a cabinet committee on investment the real solution for the investment collapse?
Obviously not, but the direction of change is unmistakable. It also points to something interesting. The fact that there has been a sudden burst of energy in the finance ministry despite the realities of coalition politics shows that the real opposition to economic reforms was from inside the Congress rather than from its partners in the United Progressive Alliance. The blame for the mismanagement of the economy in recent years should squarely lie at the gate of 10 Janpath, where political power resides.
Starting today, we present a series of essays on 2012 by some of Mint’s popular columnists.