Ashima Goyal

Growing resilience to external shocks

Ashima Goyal | Updated on September 02, 2018

Gaining strength India now has the wherewithal to withstand shocks   -  istock

The resilience is an outcome of a growing level of diversity in the economy. Growth drivers and buffers seem to be in place

Throwing a stone in a shallow pond may cause large ripples, but hardly disturbs a deep lake. A diverse system has the capacity to absorb shocks, much as portfolio diversification reduces financial risks. Holding many types of assets means that a loss in one has a minimal effect on the total asset portfolio.

The Indian economy as a whole is showing signs of having reached that level of diversity. That this was lacking earlier partly explains why India’s catch-up growth has had so many ups and downs.

The opening up of the economy has contributed to this diversity, but that has also been a major source of shocks, especially after the global slowdown and unconventional monetary policy that developed economies followed after the financial crisis. But over-reaction in policy also added to the volatility. Too much macroeconomic stimulus after the crisis was followed by too much tightening. This conservative stance meant there was no smoothing of these shocks. The focus remained on structural reforms despite an extended slowdown after 2011.

The agriculture sector

If growth rates have turned upwards despite the absence of any macroeconomic stimulus and continuing external stresses it points towards deep domestic growth drivers and growing resilience.

What are these drivers? In a populous country like India, where food is a large part of the consumption basket, a rise in agricultural productivity has to precede a growth surge for it to be sustainable. This happened in China, while a jump in food inflation was also responsible for halting India’s high growth phase of the 2000s.

Now, however, India seems to be entering a period of agricultural surpluses, although the farmers’ agitation is masking this. Farmer distress is due to over-production in relation to demand, which have kept prices soft despite attempts to raise MSP. Sustained improvements in rural roads and use of MGNREGA funds to improve irrigation and other infrastructure have raised productivity, and allowed farmers to grow high value added crops. There is a lot to do still, especially in marketing.

Rural incomes have to rise and that will have to come from diversification to non-agricultural activities. There are many signs of this. For example, Nabard’s recent ‘All India Rural Financial Inclusion Survey Report’, shows only 19 per cent of income came from cultivation for rural households. FMCG companies are reporting growing rural sales. Reducing the number of farmers is essential to raising farming income.

The industrial sector

Some of the more traditional growth drivers have also played their part. Government spending on road building and low cost housing partly explains the revival in steel and cement. As growth prospects rise there is some expansion in investment, and finally some turnaround in credit to industry. However the infrastructure-led investment boom of the 2000s is unlikely to recur.

Sterling reforms such as GST and real estate regulation have stabilised, allowing their positive effects to kick-in. The export revival of the past few months, as well as their responses to surveys, suggest that the problems small exporters were facing have tapered off — showing considerable supply-side capacity. The first few successes under NCLT and a revival in growth may finally aid in NPA resolution.

The recent provision of backdated GDP series at the 2011-12 base shows that growth comfortably exceeded 10 per cent before 2011, suggesting that the slowdown after 2011 was even sharper. The updating is based on the idea that there was a production shift captured by the use of a much larger MCA21 database of five lakh firms. The number of registered firms is expanding fast. Ten million firms have registered under GSTN, since it creates incentives for small firms to register so that they can claim input tax credit for their purchases from large firms. The formalisation and data trails created in turn allow them access to cheaper credit. At the same time, tighter regulation and corporate governance norms are cleaning out shell companies.

There are some improvements in governance but a steady deepening of democracy is also helping counter the under-provision of public goods we continue to suffer from. Horizontal social networks are complementing the vertical state hierarchy or substituting for it. A recent example of this is the Kerala floods relief effort where civil society rose to the occasion valiantly.

Social media is facilitating spontaneous organisation response to calamities or to orchestrate a viable response to long-term problems. The law on corporate social responsibility is forcing firms to participate in it.

The rapid spread of smart phone use and the mobile Internet is sparking many kinds of inclusive innovation. This unleashing of natural creativity is not only raising growth today but may help India avoid the middle income trap while sustaining services-led employment and growth.

Diversification, external shocks

To take an example of diversification mitigating external shocks, despite the exit of foreign portfolio inflows stock prices continue to boom as Indian households adopt the mutual fund investment route. A similar expansion of domestic retail debt markets should be a pre-condition for further liberalisation of foreign debt inflows.

Analysts often say that firm oil prices are a risk for the oil-import dependent Indian economy. But Saudi Arabia is likely to make up for any cuts from Iran, and there are trends towards substituting away from oil towards renewable fuels. A middling oil price range between $60-75 per barrel suits both oil importing and exporting countries, while maintaining future oil supplies thus reducing future volatility. India, for example, gains from higher export demand, and NRI remittances. It is also a major exporter of refined oil.

India’s large domestic economy insulates it to some extent from the US-China trade wars. It may even stand to gain if it participates in growing emerging market trade, captures export markets China vacates, and focusses on the domestic market if it gets its industrial act together.

During external stress, however, domestic demand cannot be neglected. Despite the high quarter growth numbers there are vulnerabilities in consumption and investment. Limits placed on deficits are likely to slow down government expenditure.

Macroeconomic policy must acquire the confidence to act counter-cyclically. It must not be caught in the risk-averse trap of throwing good money after bad. The view tends to be the country has sacrificed so much to reduce inflation, so we cannot afford to relax now.

India must have enough policy bandwidth now to counter external shocks and keep growing. Despite the sacrifices, India has not been able to prevent a return of macroeconomic vulnerability. Policy that crisis-proofs growth has to be more nuanced.

The writer is a part-time member of EAC-PM. The views are personal.

Published on September 02, 2018

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