A cover story in The Economist (February 3, 2007) publicized concerns about the Indian economy. Until then, many in industry and in the urban middle class thought that India was on a roll. For them, this Indian century and India’s economic destiny were manifest.
Three years of sustained growth in gross domestic product, rising industrial production and exports, a strengthening rupee, soaring foreign exchange reserves, the respect shown to Indian nationals overseas, the growing belief that India is the ‘knowledge society’ with brainy Indians taking over the jobs of many specialized and educated Americans and others, the Arcelor-Mittal merger, the Tata takeover of Corus, takeovers of foreign companies by Suzlon, the Aditya Birla group and others, and the books and articles hyping India gave the Indian intelligentsia the confidence that India had at last not only broken out of the ‘Hindu’ rate of growth of 3 per cent but also reached a new norm of 9 per cent.
The Economist article reminded us of other concerns. Inflation, high national debt, rising current account deficits, widening income differentials, creaking infrastructure, poor government delivery of services, dismal standards in education, and declining agriculture had to be tackled still. To tackle inflation, the finance minister reduced tariffs on palm oil, cement, sugar and some other products, unsuccessfully bullied the cement industry to roll back prices, banned forward trading in wheat and pulses, and the Reserve Bank of India squeezed liquidity. The RBI soon again raised the cash reserve ratio and interest rates. Higher interest rates have hurt borrowing for home ownerships, car purchases and of other consumer durables — some of the drivers of growth for the last three years.
Some said inflation was caused by supply constraints of wheat, pulses, rising vegetable prices probably owing to rising transport costs, higher prices of fuels, steel, aluminium, cement and so on, due to shortage of production capacities, and not because of excess liquidity driving demand. So monetary measures might have little effect until production increased, depending on the next crop imports if possible and addition of manufacturing capacities to augment supplies. These adjustments would take at least one harvest season and more. Reducing liquidity and higher interest rates would therefore hurt growth but not reduce inflation. In fact, something has worked. Inflationary trends are subsiding.
The RBI cannot be faulted for targeting inflation. Controlling inflation is a task that the RBI has performed well since the double-digit inflation of the early Seventies. A strong anti-inflationary policy tries all available weaponry: liquidity squeeze, higher interest rates, stimulating supplies, lower indirect taxes and so on.
But the economy has downsides that must be dealt with. Income differentials have widened. Organized sector employment is largely in government. Most people are in casual or self-employment. There is little job growth. Price rises of common household consumption goods hurt these mostly poor households. To say that inflation is to be preferred so long as there is growth is cruel to the poor.
Growth will slow down this year, but only marginally — perhaps a maximum of 1.5 per cent. Inflation has slowed but prices will not fall, because government spending is rising sharply. The budget has allocated large funds for infrastructure — roads, railways, power, oil and gas, urban renewal, rural development, agricultural investments, rural employment, education and health. These expenditures will stimulate incomes, consumption and GDP growth. So will public-private investments in power, oil and gas, telecom, airports, and so on. The fall in private expenditures, owing to higher interest rates and credit squeeze, shows the dichotomy in policy that squeezes liquidity to reduce (primarily private) demand, and the massive increases in government expenditures.
Industry might find it more difficult to raise fresh equity because attractive bank deposit rates will divert funds. However, the major part of new primary issues is from mutual funds and foreign funds. Fresh equity may not be hurt by much; nor will companies’ ability to raise borrowings, especially overseas. Flow of overseas funds to Indian companies as borrowings at lower interest cost than in India may not slow down because the hype about India remains. Investments by overseas Indians will add to this.
Much of the foreign institutional investment is said to be of Indian money held abroad coming back through tax havens like Mauritius. Mauritius has, for some years, been the major source of foreign direct investment and FII in India. Perhaps there is also a lot of inflow of savings from abroad by non-resident Indians who are sending money home for investment. The growing numbers of Indians going abroad for short-term jobs (three years or less) are even more likely to be sending their savings to India for investment. Investments in India are more profitable than they are in China. Overseas investors looking for good return and safety of capital are today more likely to look at investing in India than in many other countries. Funds will not be short for investment. A stronger rupee might hit exports, especially of information technology, and aggravate the deficit on current account especially if customers demand lower dollar prices. Early indications suggest that this might not be a problem.
The rise in wheat procurement prices and the import of more expensive wheat that is then sold at subsidized prices domestically, with lower import duties, are also a policy contradiction. Hopefully, we will soon see a regime where Indian wheat prices are close to international ones and government subsidies are better targeted so that inefficiency, waste and the cost of subsidies are brought down. Incentives to grow more wheat must also improve.
The Indian economy has entered a new growth path. This will be sustained, especially as agriculture responds from next year to large public investments. In a good year we can hit 9 per cent growth; and even when the world economy is sluggish and we are battling inflationary tendencies, it might be 8 per cent and 9 per cent in the next year, with inflation this year at 6 per cent, unless oil and gas go up again. But oil and gas may have reached stable prices for some time.
Finally, we cannot choose growth over inflation. No one can wish for prices of wheat, pulses, vegetables, edible oils, kerosene to rise as they have this year. The poor, unemployed and casual workers have no cushion to protect them. If the rise is only in prices of manufactured goods, there will soon be additions to production capacities that will set prices right. Agricultural products, especially of items like pulses, a peculiarly Indian consumption, will have to wait for the next harvest.
The Indian economy still suffers from many constraints, especially the inability of government to deliver fully from its expenditures. Implementation of programmes by governments is inefficient, wasteful and misses most of the desired beneficiaries. The administrative system is at the heart of India’s problems of proper implementation. Change in India is slow to happen. These constraints will remain for many years. As a result, growth will remain less consistent than it is in China. Inflationary pressures will keep creeping in and hurt growth.
The Indian economy was on a drunkard’s walk for many years, stumbling, reversing, but, in the long term, remaining on a growth path. The drunkard’s walk continues, but with less uncertainty.