Photo: Pradeep Gaur/Mint
Photo: Pradeep Gaur/Mint

Beyond the new growth estimates

Policymakers should shun complacence and focus on addressing obstacles to a sustainable growth trajectory

The standard narrative regarding the Indian economy till less than a fortnight ago was that it was on a downward trajectory since the fiscal first quarter (Q1) of 2011-12 (see chart).

This was because the headwind from the global financial crisis was still blowing, pulling down economic growth and putting in place a new normal in every major global economy. Emerging markets faced a hostile external environment, with demand destruction in their main markets, and great volatility in cross border capital flows on account of uncertainty regarding the future course of US monetary policy.

The Indian economy, widely expected to fare better than other emerging markets on account of its putative greater reliance on domestic demand, went into a surprising tailspin of declining growth from Q1 of 2011-12, with about eight successive quarters of sub-5% growth.

There was rapid deterioration in the twin (current account and fiscal) deficits and consumer price inflation settled into double figures.

There was a decline in both savings and investment, particularly in financial savings as savers rushed to buy gold as a hedge against inflation.

The decline in growth was out of proportion to the decline in investment as productivity fell on the back on mounting infrastructural bottlenecks and failing governance.

There was a brief uptick to 5.7% in Q1 2014-15. This could not be sustained however as the growth impulse weakened again to 5.3% in Q2.

There was, no doubt, improvement in key macroeconomic variables, such as the twin deficits and consumer price inflation, but the jury was still out on whether this improvement was fortuitous on account of declining international oil and food prices, or structural, especially since the denominator (i.e gross domestic product) was not growing robustly.

Yes, the Indian economy had great potential on account of its demographics, the potential for further increases in savings and investment, the scope for productivity improvements, and a strong entrepreneurial class. Indeed, according to the International Monetary Fund (IMF) India had the greatest growth potential amongst major economies.

Some green shoots of recovery were also in evidence indicating that the downturn had bottomed out, and a new decisive leadership augured well for the future. Spring was in the air, but there were still serious structural and policy obstacles in the way of a full-blown recovery.

But we were not quite there as yet. The central bank dithered in pivoting on its tight monetary policy stance because it was uncertain whether the decline in inflation could be sustained. It made a hesitant, back loaded modest cut of 25 basis points in the repo rate in mid-January 2015. One basis point is one-hundredth of a percentage point.

The Central Statistical Office’s (CSO’s) base revision gross domestic product (GDP) figures of 30 January seem to have driven a coach and six through this standard narrative. It now appears that everybody had not only missed the spring but also that we were nearing midsummer as GDP growth in 2013-14 had recovered to 6.9%, and 7.4% in 2014-15, very near the new potential!

This put the Reserve Bank of India (RBI) in a dilemma in its sixth monthly monetary policy statement a few days later at a time the market was widely anticipating more frontloaded rate cuts. Instead, the central bank kept the repo rate unchanged.

We can see why. A back of the envelope calculation from the Taylor Rule of monetary policy, assuming 6% inflation (and a 6% target), 5.5% GDP growth (and a 7 % target), yields a policy rate of 7.25%. But if current GDP growth is 7% and not 5.5%, the current repo rate of 7.75% is just right!

But the greater danger lies in complacency that reduces the urgency to address underlying obstacles to a sustainable higher growth trajectory, as during the post-2003 boom that saw the economy log a few years of 9% growth despite mounting structural bottlenecks.

It is therefore pertinent to see where the Indian economy is positioned today, un-muddied by the new CSO estimates.

First, near term data on industrial production and consumer demand points to a recovery, but not to a strong one. Second, macro balances have improved, with the twin deficits declining and consumer price index inflation within RBI’s glide path of 6%, but this is at least partly fortuitous and the result of lower demand.

Third, the investment cycle is reviving through a commendable de-bottlenecking of projects under implementation, and rural wage inflation has been checked, as a result of which total factor productivity is improving. However, since bank credit offtake remains poor, a new investment cycle is still some way off.

Fourth, fiscal improvement has opened up some space for enhancing public investment in infrastructure provided subsidies are kept in check.

Fifth, agriculture and external sectors are still drags on the economy.

Sixth, Fedexit remains the joker in the pack. However, India is better positioned to weather the storm than during the taper tantrums in first half of 2013 because of better macroeconomic fundamentals, and because Fedexit may be partly countervailed by further Bank of Japan and European Central Bank easing.

Seventh, while a good beginning has been made, India still needs major structural reforms to fix supply side constraints, and confidence boosting governance overhaul to improve the investment climate to nurture the green shoots towards a sustainable high growth trajectory.

Infrastructure, agricultural markets, non-adversarial tax and environment regimes, greater flexibility in land acquisition and labour laws, dynamic leadership at the state level, and greater economic freedom and openness in general, come readily to mind.

Even so, return to 9% growth hinges on a strong, and as yet elusive, global recovery as macroeconomic parameters are becoming increasingly globally aligned.

Alok Sheel is a civil servant. These are his personal views.

Comments are welcome at theirview@livemint.com

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