Only a few months ago, the Planning Commission was talking of 9 per cent growth in gross domestic product. It also said that inflation was bad but nothing should be done that would affect growth adversely. India was being compared with China here and abroad. India was supposed to have taken a new approach to development through growth in services, and to have assured inclusive growth through massive government-funded social welfare programmes that guaranteed minimum employment, food, free health and education and other benefits to the poor. But GDP growth this year might be 7.2 per cent. It may not improve much next year. Social welfare programmes are bogged down by substantial leakages so that the poor may receive the benefits only partially, or none at all.

The setback to growth is not because of the deteriorating world economy. Effects of that are yet to hit India in full measure. The decline is owing to poor management of the domestic economic fundamentals by governments at the Centre and in the states. Monetary authorities whose mandate is to control inflation have tried their best but with severe constraints. The government was more focused on growth than on controlling inflation, and on attracting volatile foreign institutional investment inflows via Mauritius and elsewhere. It neglected fiscal control on deficit.

Government functionaries expected the anticipated continuing growth at around 9 per cent to restrain the government deficit ratio to GDP, and also debt. The government did not act against the inflation push from unbridled expenditure increases, the considerable theft by politicians and bureaucrats and spent inefficiently.

The Reserve Bank of India used its monetary weapons, raising interest rates and restricting liquidity. The measures were ineffective because the inflation was expenditure-led, and succeeded in restricting growth. The RBI governor and deputy governor argue that there is a link between growth and inflation and the levels keep changing. India’s non-inflationary rate of growth has improved over the years. The economy has been able (till 2008) to contain inflation despite higher growth. But there are factors to be watched if the limit is to be preserved and inflation controlled.

The principal ones are energy prices, food prices, capacity utilization, investment activity, and, above all, the intangible factor of business and consumer confidence in government policies and in the economy. Confidence has taken a beating in the last one year. Political instability owing to Parliament’s paralysis and the stench of corruption rising from the cabinet, along with continuing inflation and the global economic crisis, have led to loss of confidence.

India was said to be “decoupled” from the global economy because of its vast domestic market, low export dependence, attractiveness to foreign investment and the good management and regulation of its largely government-owned banking system. Indian banks were seen to have little prospect of seeing their lendings go bad. But the banks were also relatively small and confined largely to urban centres. The rural people and the poor had limited access to them. This belief in a decoupled India was reinforced when India emerged relatively unscathed from the 2008 global financial crisis. When the American economy showed some signs of revival and Europe seemed to be ensuring that the Euro remained stable by supporting the collapsing Greek and Irish monetary systems, many in India thought the crisis was over.

But this belief did not take into account the political weaknesses of the United States of America and Europe. In the US, an extremely conservative Republican Party dominated the Congress and demanded that the administration cut its deficit and debt. It was averse to any further stimulus to the economy. The Barack Obama administration was keen on protecting expenditures that helped the poor (healthcare, education, disaster relief, and so on). It would begin reducing the deficit by improving efficiencies in expenditures and raising taxes on the rich as part of a long-term programme to reduce debt.

But the political conflict has led to a policy paralysis and the American economy shows no sign of improvement. Unemployment has reached record levels and is not falling, the stock market has collapsed, the country’s credit rating has gone down, demand for housing and consumer goods is constrained, and the Federal Reserve has had to keep interest rates almost at zero. Economists feel that a substantial stimulus from enhanced government spending is essential to push the American economy out of recession, while fiscal consolidation and debt reduction should be part of a long-term programme.

A fundamental weakness of the European monetary union has always been the fact that it is a monetary union, not a fiscal union. Each country followed different fiscal policies. As many smaller and weaker countries joined the union, the new country entrants to the Euro substantially increased borrowings from European banks, giving considerable stimulus to their economies and improving the lifestyle of their people. A condition of the European monetary union was the ceiling on government deficits and debt. However, there was no monitoring and checking. Countries like Greece cheated on the numbers and accumulated debt which was not sustainable.

An impending banking collapse required support from the rest of the EU. Ireland’s government rashly guaranteed the debts of their banks without knowing the magnitude, and had to be bailed out by the European Bank and the International Monetary Fund to prevent a banking system collapse. The infection has now spread to Spain, Portugal and Italy, with questions being raised about France. Meanwhile, European governments are worried about giving up their political sovereignty over managing their fiscal economy (tax and spending ratios, and so on) that would accompany a fiscal union. Confidence has eroded in the Euro and funds have been flooding the US. The dollar has risen and the rupee has collapsed.

Capital inflows have been adversely affected. The rupee has fallen by over 10 per cent. World commodity prices, including that of crude oil, have fallen by 10 per cent to 15 per cent as global demand declined. This has not helped India since the fallen rupee neutralizes the gain from falling commodity prices. Exports have boomed because of the declining rupee but sooner or later, export realizations will fall. India’s current account deficit of around 3 per cent to GDP requires fund inflows.

India’s drawbacks are its poor governance, inefficient management and corruption in social welfare schemes, infrastructure projects and other expenditures. If funds were honestly spent, it could stimulate the economy. The lack of strong and focused political leadership is a huge constraint. Some state governments are badly led and have no financial discipline. West Bengal leads such states. If expenditures in these states were made more efficient and productive; deficits would gradually reduce, as would debt. Inept policies must be abandoned. Take the one on foreign takeovers of Indian pharmaceutical firms. It has led to a sharp rise in the price of medicines. Fuel polices must be coordinated. All energy pricing must be independently regulated. Corruption must be severely and quickly punished.

The one bright spot is a good monsoon. This means food prices may not rise further, thus giving pause to food price inflation. But crooked and incompetent procurement, storage and distribution policies might continue to hurt agriculture.

India’s high savings ratios, unlike that of the US and Europe, are another advantage. Government debt as a ratio to GDP in India, at 78 per cent, is also not too high. It is close to the United Kingdom’s 76 per cent, and below Germany’s which stands at 83 per cent, or France’s at 82 per cent and Japan’s at 197 per cent. India has shown in past years that it can contain inflation and keep the growth momentum. If it does so again, there is much scope for increasing government expenditures without raising debt further. What India lacks is political will and leadership to do the obvious.