In trouble, but not in a crisis

Emerging markets like India and China were mostly insulated from the early stages of the economic storm that was centred in the US and spread to Europe in 2007-08. But, by mid-2008, the decoupling theory broke down in the face of whatever integration had taken place already in the global financial system. The crisis engulfed everyone.

Growth slowed down across countries. Emerging markets like India and China were quick to recover, and posted positive and relatively high growth rates in 2009-10 and 2010-11. Now, following sequential sovereign debt problems centred in the Euro area, another bout of economic slowdown is engulfing the world economies, including the US. India is no exception.

India has no doubt weathered the storm till mid-2011 successfully. But when things started looking up, it found itself in the midst of a new vicious cycle of problems, mainly emanating from outside. These were also exacerbated by the not-too good political climate and the resultant inadequate public policy responses in several areas. In this milieu, both academic and analytical agencies have started pressing the panic button, attempting to undermine the inherent confidence of investors in the long term prospects of the Indian economy. The authorities seem to have woken up from inertia and hopefully will act swiftly to bring back investor confidence.

They have to strike a right balance in undertaking short-term measures without losing sight of long-term dynamics.

Growth-Inflation Dynamics

Let us take a look at the long-term growth and inflation dynamics (Table). The decade ending 2011 had several positives. GDP growth clocked the highest average rate of 7.5 per cent. Thanks to the declining population growth rate since 1981 from 2.22 per cent to 1.76 per cent in the last decade, the nominal average per capita GDP improved from Rs 4,319 in the decade ending 1991 to Rs 38,696 in the last decade. Again, thanks to moderating consumer price inflation, from an average of around 9 per cent in the decades ending 1991 and 2001 to 6.5 per cent in the last decade, the per capita GDP at 2004-05 prices had also improved by about 3 times during the same period.

After a four-decade near stagnation, the real per capita GDP assumed an exponential growth path since about the early 1990s (Graph). These long-term trends should give us confidence in restoring a sustainable, high growth path.

In the last two years, no doubt there have been certain reversals, but things are not that bleak. GDP growth fell from 8.4 per cent to 6.5 per cent, but still it is one of the highest across countries. Second, the consumer price inflation, which looked sticky in double digits during 2009-10 and 2010-11, softened to 8.33 per cent, but was still very high compared to the decadal average of only 6.5 per cent. Despite high inflation, the per capita GDP, both in nominal terms and real terms, touched its highest levels in 2011-12.

Short-Term Worries

Apart from lower growth and high inflation, there are other short-term worries, such as the widening current account deficit, depleting foreign exchange reserves and a steeply depreciating currency. These point to the priority that needs to be accorded for restoring external sector balance and investor confidence, without sacrificing the long-term strategic policy stance relating to capital account liberalisation and external debt management. Given the low interest rate environment abroad, with further easing of policy rates it may be worthwhile for the government to go in for another issue of Diaspora bonds to tide over the temporary mismatches in foreign currency needs, including those arising from the corporate and banking sectors.

The depreciating currency may be a correction, but high volatility needs to be managed. Given the high level of inflation, and other risks to inflation such as suppressed administered prices and burgeoning fiscal deficit and government borrowings, the central bank should not be in a hurry to trigger another round of aggressive policy rate easing, particularly in the forthcoming review in mid-June. That may prove to be disastrous.

The growth projection for 2012-13 has been scaled down by many, but growth is likely to be much higher than that witnessed in 2010-11, provided some enduring solutions are found to tackle the European debacle.

Economic Reforms

Even while fire-fighting short term issues, it is no doubt equally important to respond to the public cry for the much-needed next round of economic reforms to restore confidence in the potential of the economy. There is a well-known laundry list awaiting action on the legislative side, and on the developmental side, in areas such as agriculture, public distribution, mining, infrastructure, social sectors and governance.

Creating a political consensus, going beyond party politics, can help weather the current economic storm. Being in panic mode may lead to self-fulfilling expectations.

(The author is Director, EPW Research Foundation. Views are personal. >blfeedback@thehindu.co.in )

COMMENT NOW