The Hindu Business Line : Gloomy portents

The most striking cause for gloom is the international scene characterised by financial turbulence, high commodity and energy prices and slowing economic growth in the West.

With the declining trend in industrial output continuing in the first quarter and the RBI’s business outlook survey gloomier than it has been in the past four years, it is hardly surprising that the Prime Minister’s Economic Advisory Council (EAC) scaled down its GDP growth forecast for 2008-09 to 7.7 per cent, lower than the RBI’s revised estimate of around 8 per cent. The Finance Minister, Mr P. Chidambaram, feels confident of the latter growth prospect and the economy could just make his day by beating most forecasts. But the odds are that it will not because of a host of factors that the EAC points out and some it merely hints at.

The most striking cause for gloom, according to the EAC, is the international scene; financial turbulence, high commodity and energy prices and the prospect of slowing economic growth in the West are beginning to impact Asian economies. In fact, the EAC predicates a “reasonable rate of growth” on the “presumption of a return to normalcy” in the global environment. Like the RBI, it attributes domestic inflation not simply to the global commodity price rise but also to strong domestic demand. Unlike the more optimistic RBI the EAC feels the inflation rate can be brought down to 8-9 per cent by March but much of this optimism is based on hope. Commodity prices are softening presumably because of lower demand, and not necessarily increasing supply. This is a dangerous expectation because logically then, the best solution to global inflation would be a scaling down of economic growth in precisely those countries, India included, that shop heavily for energy and food. In terms of policy initiatives, it is far better to look at inflation as the result of constraints not just in food supply but also in social and physical infrastructure, a viewpoint that the EAC expresses almost as an afterthought. If such bottlenecks are to be removed, surely monetary and fiscal policy must work to boost demand and not smother it? That non-food credit growth is still healthy at 24 per cent (2007-08) is proof for the RBI of those demand pressures that have to ease and the EAC agrees, thereby undercutting its own observation.

The Council’s fears of the fiscal deficit overshooting the target by a good 5 percentage points on account of bloated subsidies and other off-budget liabilities have come not a day too soon. Such fears will be justified if government borrowings elbow out productive investments. With high interest rates and falling business profitability, that prospect may not be too far off.

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