Slipping up on reforms front will prove costly, says Subbarao

Reserve Bank of India Governor D. Subbarao has said the current account deficit at the present level of about 5 per cent of the GDP is unsustainable.

“Over the last two years, India’s balance of payments (BoP) has come under growing pressure as evidenced most clearly by a large and increasing current account deficit (CAD),” Subbarao said delivering a lecture on “India’s Macroeconomic Challenges — Some RBI Perspectives” at the Federation of Karnataka Chamber of Commerce and Industry (FKCCI) here on Saturday.

Scaling New Highs

“The CAD last year (2011-12) was 4.2 per cent of GDP, historically the highest; the CAD during the current year is expected to be even higher,” he said.

“Many will recall that India went through a balance of payments crisis in 1991 which, in fact, triggered wide-ranging structural reforms that gave a market orientation to the economy. Despite India’s growing integration with the global economy, the external sector remained robust for over 15 years after that,” he added.

The current episode of BoP pressures, when the CAD is higher than it was at the peak of the 1991 BoP crisis (3 per cent of GDP) is, therefore, causing apprehensions about whether we have the capacity to stem the pressures and restore the BoP to a sustainable path. The Governor said: “The increase in CAD is quite evidently a consequence of imports growing faster than exports.”

Managing the political economy of fiscal consolidation is another challenge. He said “The large fiscal deficit of the Government remains one of India’s biggest macroeconomic challenges. Received wisdom today is that it was the fiscal profligacy of the 1980s that spilled over into the external sector and fuelled the balance of payments crisis of 1991.”

In 2011-12, the combined fiscal deficit of the Union and State Governments was 8.1 per cent, quite close to the figure of 9.1 per cent in the BoP crisis year of 1990-91. Quite understandably, there are concerns about the adverse macroeconomic consequences of the twin deficit problem — a large and persistent fiscal deficit along with a high CAD. “There has been some very welcome, although much delayed, action on correcting both the CAD and the fiscal deficit over the last six months,” he said.

Tariffs up

The Government has raised customs duty to restrain gold imports. He pointed out that India can accelerate growth and improve welfare only if we effectively implement wide ranging economic and governance reforms.

Subbarao said “slipping up on this will amount to a costly and potentially irreversible squandering away of opportunities. The Government has to take the lead in the process of economic revival. As the central bank and as the regulator of large segments of the financial sector, the RBI too has an important role to play.”

To address the country’s macroeconomic challenges, RBI has listed three challenges: Managing growth-inflation dynamics, mitigating the vulnerability of external sector and managing the political economy of fiscal consolidation.

Speaking on managing growth-inflation dynamics, the RBI governor said the country’s growth-inflation dynamics pre-crisis and post-crisis present a study in contrast.

“In the three-year period before the crisis, the economy expanded by 9.5 per cent on average, aided by growth in fixed investment above 15 per cent per year,” he explained.

“This expanded production capacity to match growing demand and kept core inflation in check. Post-crisis, the story reversed. Investment declined to half its pre-crisis rate whereas consumption demand remained at the pre-crisis level until last year, owing partly to the Government’s entitlement and welfare programmes, opening up a positive output gap during 2009-11 and stoking core inflation,” he added.

>anil.u@thehindu.co.in

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