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Implementation issues mar UPA show as economy slows

Implementation issues mar UPA show as economy slows
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First Published: Thu, May 22 2008. 11 28 PM IST

Updated: Thu, May 22 2008. 11 28 PM IST
New Delhi: If people get governments they deserve, do governments, in an election year, end up with economic problems they deserve?
After robust economic growth in the first four years of the United Progressive Alliance, or UPA, the last year threatens to be any finance minister’s nightmare: increasing inflation, declining industrial production and slowing domestic and global growth.
The negative developments, following each other in quick succession, have been caused partly by adverse international developments.
It is now feared that the confluence of negative events may dent business confidence and slow investments, the main driver of the 8.7% economic growth recorded over a five-year period ended March.
“These are difficult times,” Union finance minister P. Chidambaram said last week after inflation rate for the week ended 3 May touched 7.83%, the highest in three-and-a-half years. “But, there’s a silver lining. Prices of primary articles are declining and when steel and cement price cuts kick in, we expect inflation will moderate.”
Meanwhile, Prime Minister Manmohan Singh said this week that inflation would be moderated by 15 September. He also asked the people of the country to be “patient” as the government did not have a “magic solution” to control prices.
“...My request to the public at large and to political parties is give these measures (already announced by the government) a chance to succeed,” Singh told reporters on his return from a two-day visit to Bhutan.
The key question being asked is whether the UPA government could have done more over the four years that could have helped mitigate the impact of an economic downturn, especially at the global level. The United Nations on 15 May forecast global economic growth in 2008 would be 1.8%, 2 percentage points lower than the previous year’s 3.8%. Investments have been the key to economic growth in the last few years, increasing to a record 35.9% of gross domestic product (GDP) in 2006-07. But, this may be changing.
N.R. Bhanumurthy, associate professor at New Delhi’s Institute of Economic Growth, said there are indications of “some holding back of investments” in the wake of recent negative economic developments.
Industry lobby body Federation of Indian Chambers of Commerce and Industry (Ficci) released a survey in March which showed that business outlook had begun to take a knock by the last financial year as half of the 392 companies sampled said economic conditions had worsened compared with a fifth who felt the same way in the preceding survey. Economic growth in 2007-08 is forecast by the Central Statistical Organisation to slow by 0.90 percentage point to 8.7%. Chidambaram and the Reserve Bank of India (RBI) forecast 8-8.5% in the current fiscal.
India’s increasing integration with the global economy (foreign trade makes up about one-third of the nominal GDP) means that the domestic economy cannot escape the fallout of a global slowdown.
The surge in international crude, foodgrain and commodity prices have pushed up inflation rate and inflationary expectations in India, triggering a cycle of hardening interest rates that has already hurt businesses dependent on consumer loans.
The growth in industrial production in March dropped to a six-year low of 3%. The slowdown in production was across the full spectrum, but production in consumer durables fell year-on-year by 2.1%.
Chidambaram provided a fiscal stimulus in the last Union budget in a bid to shore up consumption, but are the recent measures a case of doing too little too late to mitigate the impact of a global slowdown? Have the UPA’s attempts, which have yielded little success, to combat commodity inflation and recent political and social developments involving Naxalites, leftist extremists, and terrorists dented India’s image and made international investors uneasy?
The Congress-led UPA is a coalition government propped up in Parliament by the Communist parties that oppose most economic reforms. They have so far blocked reforms in banking and insurance sectors.
Gurudas Dasgupta, a Lok Sabha member of the Communist Party of India, maintained that the UPA economic policy was not hamstrung by the compulsions of coalition politics. The UPA, beyond a point, did not push through key legislations as the Communists refused legislative support. On most other economic issues, the UPA did pretty much what it wanted, he said.
“The economic policy as reflected by budget is dictated by corporates,” said Dasgupta, as an example of the space the UPA has in framing economic policy.
In the areas where the UPA has had some leeway, independent observers said performance could have been better.
Bhanumurthy pointed out that even legislation notified such as the Special Economic Zone (SEZ) Act tends to get bogged down in implementation issues. There are mixed signals in foreign direct investment in retail and infrastructure investment in the second year of the 11th Plan seems inadequate, he added.
A five-year stock market boom and easy access to global debt have aided the investment boom in India. Simultaneously, the government has announced its intention to strengthen and deepen the domestic markets for debt and derivatives, which could ease access to finance. Four years on, it’s work in progress.
Joshua Felman, senior resident representative of the International Monetary Fund’s India office, said India’s investment boom needs tools such as a deep bond market and interest rate and exchange derivatives to sustain it.
Depth in the bond market and currency markets and a liquid derivatives market are also needed to provide for a smooth transmission of monetary policy measures of the RBI. The central bank has taken measures to suck out liquidity and push interest rates over the last two years. During the period, the cash reserve ratio has been increased 10 times to 8.25% and the repo rate has been nudged up five times to 7.75%.
The monetary policy transmission has not been effective as long-term bond rates and deposit rates have been relatively sticky, Felman said.
RBI recently announced its final road map to start trading in currency futures two years after Chidambaram first thought of announcing its introduction in a budget speech.
The move on currency futures comes in the wake of a growing problem between banks and their clients for exotic derivatives on charges of mis-selling.
The government’s solution to the growing problem is the introduction of currency futures, a senior finance ministry official had recently told Mint.
Even as the government could have done more during its tenure, the recent spurt in economic growth is the outcome of the continuity in domestic economic policies since reforms began and global factors, economists said
Chidambaram, in his press conferences, has linked the overlap in the time frame of record economic growth to the UPA’s innings at the Centre.
Economists trace the roots of the current growth to a combination of a surfeit of international capital looking for returns in emerging markets and deregulation of interest rates in India. The government loosened control over interest rates in steps following economic reforms in 1991. A watershed in the sequence was in 1998, Bhanumurthy said. Between 2000 and 2004, rates in India softened in line with global rates, which reduced the cost of capital paving the way for an investment boom.
A simultaneous housing boom was triggered by a combination of cheaper loans and tax concessions. The emerging economic challenges could be worsened by issues relating to the beating India’s image could be taking. The government’s measures to tackle inflation include threatening to cap prices through administrative fiat, using sections of a controlled economy legislation such as Industrial Disputes Act and ban on futures trading in some commodities.
The threat of sudden price controls bother international investors. Alok Gupta, managing director and CEO of Axis Private Equity Fund, which recently raised money from international investors, said investors are a bit concerned by the threat of a government fiat. A belief that certain basic steps will be taken to keep the growth momentum intact still remains, he added.
The recent decision to ban trading in some commodities to combat inflation has been criticized.
“It was (a) very bad (idea for the government last week) to have banned soya oil, even potatoes where prices were falling, and rubber. Here is a situation when you have a total inability of a lot of people to take a sensible view even on the pluses,” Abhijit Sen, a Planning Commission member, told Mint in an interview published on 15 May. Sen was the head of a panel that recently submitted to the government an inconclusive report on commodity futures.
The inflow of huge amounts of international capital is linked partly to looking at the glass half full. The economy’s growth momentum has overwhelmed news on political and other social problems.
Even as growth momentum of the economy moderates, serial bomb blasts such as those on 14 May in Jaipur—an important tourist centre—could turn overseas investors jittery.
If a confluence of domestic and international factors drove growth in the last five years, a reverse in trend could hurt the economy.
In 2007, capital inflows led to the rupee’s appreciation against the dollar and loss of competitiveness of some exporters. The trend has reversed. The rupee on Thursday closed at Rs42.96.
“While inflows have been the problem in recent years, outflows could well be a problem in the future,” said the recent Raghuram Rajan report on financial sector reforms.
K. Raghu from Bangalore, Baiju Kalesh and Ammar Master from Mumbai, and Bloomberg contributed to this story.
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First Published: Thu, May 22 2008. 11 28 PM IST