Time for stimulus, not cutbacks

What do the following news items have in common: the steady build-up in core inflation to near double digits that may force the Reserve Bank of India to stick with its rate hikes; a deteriorating power situation (as if it wasn't bad enough) with coal shortages prompting northern and eastern states into heavy overdrawals; and advance tax payments by Indian large firms that rose a modest 10 per cent in the second quarter ending September, against double that in the first quarter?

Simply this: the organised economy, much as policymakers may hate to admit it, is slowing down and that, if the power situation doesn't improve fast — and it is not likely to —then the slowdown could get worse.

Right now, some of the problems of the organised, urban-based economy, that policymakers count on to keep India among the fast-growing nations, can be perhaps alleviated by reducing interest rates and excise duties. But the fact of low demand being structurally built into the economy, with so many below the poverty line, will not go away with such tinkering.

Growth in investment, consumption and exports is showing signs of slowdown; hence, the Commerce Ministry is trying out politically correct, but economically futile, measures such as special incentives for “labour-intensive” exporters, as demand in the traditionally strong markets of US and Europe has been sliding on account of recession.

Demand also has been falling for Indian textiles, for instance, because other competitors such as Indonesia, Bangladesh Mexico and Thailand, not to mention China, have dislodged India from its position among the top five suppliers in the American apparel markets.

Domestic woes

But demand is slowing in the domestic economy too, and that is something that should worry policymakers even more; among the emerging economies, India weathered the post-September 2008 global wind-down in large part because of the resilience of its domestic demand. That has been its strength, and it is now its biggest weakness.

The latest CRISIL report on a lower GDP growth rate merely confirms what was implied in the Reserve Bank's persistent rate hikes and reported in its quarterly reviews: “consumption linked” (CRISIL) or in the central bank's words, “interest sensitive” sectors such as real estate and automobiles would face an increasingly reluctant consumer. Many commentators including CRISIL now conclude a slowdown is upon us; but the RBI had warned as early as July in its first quarter review: “Aggregate demand decelerated in Q4 of 2010-11 mainly due to investment slowdown. Corporate investment intentions also moderated significantly during H2 of 2010-11. There are no signs of improvement in investment during 2011-12 as yet. Private consumption demand may be adjusting downwards, but still remains strong.”

Two months later. in its mid-quarter review on September 16, the RBI had edited its prognosis on private consumption, dourly noting the consequences of its rate policy thus: “As monetary policy operates with a lag, the cumulative impact of policy actions should now be increasingly felt in further moderation in demand…”

As India runs into the festive season, real estate and automobile firms are not a happy lot: falling demand makes it all the more difficult for firms to pass on higher input costs to the consumer.

The return of non-food inflation since August, noted by the central bank in its mid-quarter review, suggests firms may be saddled with the burden of higher input costs and that may further deter any residual motivation for investments.

What we may now witness is a spiral of falling private consumption and investment.

Options for reversal

What are the options to reverse the gradual winding down of output and growth evident since early this year? Demand needs to be restored; India can do little to ramp up world demand (notwithstanding the exalted emptiness of G-20 rhetoric); it can do something for the domestic economy. The first thing policymakers will have to do is to get ready to fill the space vacated by private investments, should private consumption continue to slide. As in the post-September 2008 scenario, the government will have to consider steps that can both encourage spending and increase, at the margin, purchasing power of more Indians even as the RBI tries, in vain, to retain the value of existing purchasing power.

A public stimulus for 2011-12 and beyond may work the same benefit that the earlier expansionary policies did after the gradual drop in growth in the second half of 2008-09 and the following year. If India managed to remain within the elite club of emerging nations, it was in large part because of those stimulus packages—the Sixth Commission Pay awards, the debt waivers and the fiscal reliefs for industry.

In retrospect, growth during 2010-11 was not the outcome of any substantial policymaking that could have led to spurts in investments in the core sector, but of a brief detour from the straight and narrow path of “fiscal responsibility”.

Stimulus as entitlement

Perhaps the time has come for a similar objective, but with a more co-ordinated stimulus so as to retreat from a clearly dangerous situation of falling output and rising inflation. Acting on its own, the RBI may arguably curb inflation but it will definitely curb output and demand, too.

Where should the government begin? Ironically, it already has: the raft of legislations that aim to universalise entitlements for the poor put together could add up, in the long run, to the most sustained stimulus for the generation of incomes, and thus the broadening of purchasing power.

The successful implementation of intended entitlements, stripped of the dreary debates on poverty “lines”, would do far more to create a sustained expansion of growth, than short-term cuts in excise duties or reductions in interest rates to shore up demand.

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