The last year has been an extremely tough year for the Indian economy. Practically everything which could go wrong did turn sour. For much of the year, the United Progressive Alliance government has been a rudderless ship, buffeted by storms several of which were of their own making. Most sectors of the economy limped along, with the index of industrial production fluctuating quite alarmingly. In fact, the index for November shows that factory output was slightly lower than that of the previous year. Of course, Montek Singh Ahluwalia, the deputy chairman of the Planning Commission, has claimed that the November figures are somewhat misleading partly because of the base effect — November 2011 had witnessed a sharp rise in factory output.
While there is some truth to the assertion that monthly figures are unreliable because they tend to fluctuate so much, there is no getting away from the fact that the average rate of growth for the entire calendar year has been relatively low. While it is still too early to get a precise figure, even the government does not claim that the rate of growth will be in excess of 5.5 per cent, quite a fall from the 8-9 per cent growth routinely reached in the recent past. To make matters worse, prices have kept going up and up. Since the rise in prices has been well above comfort levels, the Reserve Bank of India has refused to reduce interest rates. This has meant a complete absence of any monetary stimulus to the beleaguered economy. The slowdown in the economy implied that government tax revenues were not very buoyant. On the other hand, there was very little attempt to curb government expenditures, and so the fiscal deficit assumed alarming proportions.
Finally, the current account deficit has also grown by leaps and bounds. Not surprisingly, Indian exports stagnated because the world economy is yet to come out of the recessionary phase. Imports into India remained high in spite of the slowdown in the economy because of oil imports. Indians’ love affair with gold did not help either — a significant part of import expenditure was on account of the yellow metal. The huge fiscal and current account deficits caused several of the rating agencies to threaten to downgrade India’s credit status.
Through all this, the only silver lining has been the performance of the Indian stock market. The Sensex and the Nifty rose by roughly 20 per cent during the year; savvy investors clearly reaped larger gains. Global comparisons are also flattering with the performance of the Indian stock market during 2012 being second only to that of Turkey. Indian stocks, which were being shunned by foreign investors in 2011, suddenly became the flavour of the month. This has been of immense benefit, at least in the short run, because the sizeable inflows of foreign exchange on account of portfolio investment helped to finance the current account deficit. The depreciation of the rupee would have been far greater if foreign investors had kept away from Indian stocks.
Is the booming stock market an advance indicator of happier times to come for the Indian economy? Ahluwalia certainly seems to think so because he has asserted on more than one occasion recently that the economy has bottomed out. There is some independent — that is, non-governmental — support for this assertion because most forecasts of the likely rate of growth of the economy in 2013 exceed 6 per cent. This would certainly be higher than the eventual growth achieved in 2012.
But what has changed on the ground? Why should we expect the Indian economy to be out of the woods? In spite of liberalization and the removal of some governmental controls, the Central and state governments continue to exert a massive influence on the economy. And so it makes sense to analyse whether government policies have changed in any significant way.
The biggest change seems to be in the mindset of the UPA government. Perhaps senior Congress leaders realized that the policy of drift was sure to get them a sound thrashing in the 2014 general elections. This realization has resulted in the UPA government effecting changes in policy and introducing reforms which required a modicum of political courage since they were controversial and unpopular in the short run. In fact, virtually all members of the ruling coalition have been against these changes (at least publicly), and the principal member, the Trinamul Congress, actually left the coalition over the issue of allowing foreign direct investment in the retail sector.
While this measure has generated the greatest heat, it has very little direct significance in the short run. Although several foreign retail chains will definitely operate in India in the foreseeable future, none of them will have any presence during this calendar year simply because large-scale entry requires a lot of preparation and time. But, this decision of the government has tremendous signal value immediately. This is the first instance in quite some time where the government has asserted that its economic policies will be dictated by economic principles and not immediate political compulsions. This must inspire confidence in both Indian and potential foreign investors. At least some of this increased confidence will hopefully translate into new projects.
The government has also taken several other steps that indicate its resolve to pursue sound economics. For instance, it has raised prices of petroleum products and put a cap on the number of cooking gas cylinders that households can buy at the hugely subsidized prices. It has also indicated that it will gradually use cash transfers to replace subsidies given in kind, for instance through the public distribution system. One of the most important short-run objectives of the government must be the containment of the fiscal deficit to manageable limits.The increase in process of petroleum products will slash the subsidy bill and so go a long way in bringing some order to government finances.
Finally, the external environment is also in much better shape than it has been ever since the global recession, which started in 2008. The last minute compromise between the Republicans and President Barack Obama has meant that the American economy will not fall over the “fiscal cliff”. Since the American economy was already exhibiting fledgling signs of recovery, it is most likely that it will be in even better shape during this year. Given its huge size, this augurs well for the world economy. Not surprisingly, world stock markets are in better shape than they have been in the last couple of years. Indian exporters will in all probability do much better this year.
Of course, in spite of its diminished relative size, agriculture remains an important sector and its future will be heavily influenced by the rain gods. So, while a lot can still go wrong, there is no doubt that the short-term prospects for the Indian economy today are much brighter than they were a year ago.