The Hindu Business Line : Indian economy: A balance-sheet

Healthy growth estimate of around 7.5 per cent, a soaring Sensex, large forex reserves and some lull on the crude oil price front can generate euphoria about the economy. But will it last? Emphasising that growth without stability can be hurting, A. Vasudevan says that it may be useful for policy-makers to have a medium-term perspective even while viewing the short-term developments.

AS 2005 is ready to roll out and a New Year waits to roll in, a quick look at the likely macro-economic outcomes by the end of the fiscal may be worth it. A number of observations by analysts and policy-makers in recent weeks leave the impression of an euphoria being generated about future economic prospects — similar to the canvassing of `India Shining' over a year ago. The latest edition is largely created by what seems to be the consensus growth estimate of around 7.5 per cent and the soaring Sensex against the background of large foreign exchange reserves and some lull on the crude oil price front.

There are also a number of other arguments cited in favour of the bullish outlook. Interest rates are considered to be soft enough to be conducive to investment. There is said to be a quiet revolution in infrastructure investment. The pick up in credit, the large initial public offerings by both financial and non-financial companies, the large pool of liquidity, the improvement in the profitability of banks and the recent depreciation of the rupee against the US dollar are viewed as additional positives.

Balance-sheets of most corporations look generally good. India Inc is increasingly looking for acquisitions abroad. Financial stability is being viewed as assured by the keen surveillance of the regulatory authorities. It is also said that fiscal deficit and commodity price inflation are tolerable.

All these are indeed heartening. However, one needs to temper the mood with caution so that the current perceptions about the economy are substantive. The deceptively seductive overall growth figure has already led to a belief that 10 per cent can be achieved if aided by policies and investments in infrastructure. But it is the financial services segment (finance, insurance, real-estate and business services) that mainly props up the current growth estimate.

It would be analytically useful to examine whether the financial segment's growth is real and conducive to the expansion of the commodity producing activities. Specifically, has the recent phenomenon of sharp yearly increases in the wage and technology upgradation bills of the financial services segment led to the current estimates? Are the output gains of the commodity producing sectors endogenously driven? What is the nature and strength of the link between the services and the commodity producing sectors?

These hard questions apart, it is important to ensure that in countries where labour is abundant and unemployment rampant, growth absorbs labour. There is not much evidence of the services sector making a difference to the unemployment situation. It is becoming increasingly evident that the commodity producing sectors would have to grow at a faster rate than at present to provide large additional employment.

Intentions need not always translate into reality within a year or two. This is the case with infrastructure investment. How much of the money raised by large and medium business houses is used for infrastructure as well as expansion of capacity and diversification of activities in manufacturing and how much of it is used in the stock market or for acquisitions of other business entities is a question that needs to be asked and satisfactorily addressed.

More often than not, infrastructure projects do not take off quickly because they often are vehicles of irregularities and corruption. In view of the delays in implementation partly due to public interest litigations, the size of financing would go beyond the budgeted amounts. In addition, the politically sensitive issue of the ownership of infrastructure projects continues to be a major constraint. It is not enough, therefore, to go merely by the proposals and approvals of the infrastructure projects. If, however, the proposals were acted upon, the bottlenecks to production would ease but only in the medium to long term, of three-seven years.

The credit pick up raises questions as to whether it has supported small and medium enterprises and the rural sector to the extent warranted. The rates of interest charged by banks are also asymmetrical, with large borrowers getting the most favoured treatment. The relatively low interest rates for large borrowers coupled with large proportion of credit flows to such borrowers should be treated as what may be called financial discrimination. This is especially so in view of the absence of access to credit for a vast majority of borrowers.

In this context, pursuing the objective of financial inclusion — a term of art to describe the same old objectives that were articulated way back in 1969 after the nationalisation of 14 major Indian banks — assumes enormous significance. However, the strategies to realise the objective year by year during a term of, say, five years seem to be overtaken by concerns about complying with Basle II norms that seem to suggest near-zero tolerance of lending risks. Would financial inclusion be served by proposals for bank mergers and risk-less bank behaviour?

Regarding the asset prices (stock and housing prices), the upward movement has been mind-boggling. Whether they reflect the so-called fundamentals and whether they can be sustained are issues worth examining. The policy-makers are caught in a dilemma in that they cannot openly air their concerns simply to ensure that markets do not react negatively. With no good information about the household debt, the policy-makers, recognising the risks associated with any sharp declines in collateral values, have correctly prescribed increased lending margins for housing. But this has not halted the upward movement in asset prices. It appears that there is enormous liquidity outside the banking system. It needs to be asked if the current policy dilemma can be answered at least partially by raising the interest rates and by fiscal disincentives.

The recent depreciation of the rupee vis-à-vis the US dollar after being range-bound for long shows maturity of judgment on exchange rate management, notwithstanding the criticism that it has hurt a number of market participants. This would help promote exports as well as inflows. In view of the uncertainties concerning future commodity price movements, it would be useful to have a creeping rather than a sharp depreciation. One of the critical downside risks pertains to commodity price behaviour. There is an overall consensus among empiricists that the Wholesale Price Index would go up by about 5 per cent this fiscal.

If international crude oil prices do not go up in the coming months, inflation expectations would be under control. But retail prices of consumer goods other than those where registered prices are recorded have at times flared up sharply due to frequent interruptions in supply due, for example, to transportation difficulties and natural disasters.

The fiscal management over the medium term needs to be presented in some details since its credibility provides substance to investor sentiment.

Cutting down the size of the public sector partly through divestment, undertaking tax reforms and setting in place improved transparency practices have assumed urgency given the growing demands on the Government for meeting expenditures associated with the social sectors, terrorism, law and order, and natural disasters and given the need for accountability.

Effective articulation of policies matters most to influence the market sentiment. Policy-makers have a critical role to play in this regard because growth without stability can be hurting. It is, therefore, useful to keep a medium-term perspective while viewing the short-term developments.

(The author, former Executive Director of the Reserve Bank of India could be accessed at asurivasudevan@hotmail.com)