Prime Minister Manmohan Singh made a promise to the nation last Friday. At the end of his speech, he said, “I promise you that I will do everything necessary to put our country back on the path of high and inclusive growth." Forget the cynicism, totally justified of course, about the promises of politicians for the moment. What’s interesting is that throughout his speech, he linked growth to redistribution, stressing that the latter was impossible without the former.

The UPA government has done quite a bit of redistribution. So much so that wages for unskilled rural labourers have doubled between March 2008 and March 2012, partly because of the government’s flagship jobs guarantee programme. They took the easy way out, preferring to increase subsidies rather than go in for investment.

Consider the numbers. In 2003-04, the central government’s capital expenditure was 23.2% of its total expenditure; in 2011-12, it was 11.9%. In 2003-04, subsidies amounted to 9.4% of the central government’s expenditure; in 2011-12, they were 16.4%. That’s not all. In 2011-12, the central government’s subsidy bill was a scary 2.6% of nominal gross domestic product, higher than the 2.4% it was in 1990-91. That might have been the reason why the 1991 crisis motif figured so prominently in Singh’s speech. Despite his assertion to the contrary, his government seems to have firmly believed that money grows on trees.

Increasing subsidies was not a problem when the economy was growing at 9%. Growth led to higher tax collections and lowered the fiscal deficit in spite of higher expenditure. The stock market boom meant companies had no problems raising capital, which, in turn, led to investment. All that changed after the financial crisis and the downturn in the economy. For a while the government tried to buy growth by increasing its deficit, but that only led to higher inflation, higher interest rates and a slowdown in investment. In short, the government has run out of soft options. That is why the Prime Minister said, “At times, we need to say no to the easy option and say yes to the more difficult one." It’s another matter that he should have opted for the more difficult option long ago.

The bloated subsidy bill also threatened a downgrade by rating agencies, which would have pushed India’s credit rating below investment grade. Maybe this, too, was at the back of Singh’s mind when he made the repeated references to the 1991 crisis.

How is the Prime Minister going to deliver on his promise? He has underlined the need to curtail the fiscal deficit. The finance minister, too, has hinted at taking measures that will lead to an improvement in government finances. And the measures taken by the government and those promised have already led to a marked improvement in business confidence.

Reducing the fiscal deficit, however, will in the short run mean lower demand and, therefore, lower growth. In a recent presentation, the Reserve Bank of India (RBI) governor D. Subbarao said that while the debate in the advanced economies was that of austerity versus growth, in India the debate was of austerity for growth. But will the government be able to reduce subsidies any further? Even after the increase in diesel prices, the subsidies on petroleum products will be far more than the amount budgeted for. And will the government be prepared to jettison its precious food security legislation? Will it also forsake pre-election giveaways in the 2013 budget?

There is, though, one way to offset the impact of tighter fiscal policy—through easing monetary policy. Banks have already started to cut lending rates. But the key to further easing by RBI will lie in lower inflation. The central bank’s estimate of inflation at the end of March 2013 is 7%, which doesn’t leave much leeway for aggressive easing. Monetary expansion by the US Federal Reserve, the European Central Bank and the Bank of Japan has led to money flowing into commodities, pushing up prices. Non-food manufacturing inflation has been going up, indicating firms still have pricing power. And if inflation doesn’t come down, it will be difficult for the central bank to justify lower policy rates. Note also that bank deposit rates today are far higher than they were in 2003-04, when the last boom started. Also acting as a constraint on investment will be the land acquisition problem, the mining bans as well as weak export markets.

It’s likely the government will try and keep up the positive momentum, in spite of the obstacles mentioned above. The good news is that the economy appears to have bottomed out and there has been some improvement in capital expenditure. The timing of the government’s volte face on reforms has also been impeccable, coming as it does on the heels of co-ordinated monetary easing by the central banks of Europe, Japan and the US and a rush of money to emerging markets.

But ensuring higher growth, for all the reasons mentioned above, is going to be an uphill task. After years of behaving as if money grows on trees, it’ll be difficult to kick the habit.

Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com.

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