World income was growing comfortably at about 5 per cent a year in the early years of this millennium. Then in 2008, growth suddenly slackened; by the end of the year, industrial countries’ domestic product was declining sharply, and growth in underdeveloped countries had virtually ceased. The downturn was so drastic that there were fears that the world was about to see another great depression like the one in the 1930s, which did not end until World War II forced all warring countries to overspend for survival and pulled their economies up out of depression. But after three quarters of deep decline, world growth recovered in 2009; by the end of the year, it had recovered to almost 6 per cent a year.

Then it started falling again. By early 2011, it had fallen to 3 per cent; according to Organisation for Economic Co-operation and Development estimates, growth had virtually stopped in industrial countries, and most growth was coming from developing countries, primarily China and India. Unemployment in the euro zone was 10 per cent of the labour force; in the United States of America, it was only slightly lower. In Japan it was about 5 per cent; but that is because employers in Japan do not dismiss workers so readily as in the West. Gross domestic product was declining much more sharply in Japan than in Western countries. Interest rates on the government debts of Portugal and Ireland were 8-10 per cent — as high as on Indian debt, although their inflation was negligible compared to India’s 10 per cent. The industrial West was clearly in trouble.

Usually, when world growth slumps, commodity prices come down. But this time, commodity prices also ruled high. Crude price was close to $120 a barrel; prices of food, agricultural raw materials and metals were some two-and-a-half times as high as in 2000. No wonder that expectations throughout the Western world were pessimistic. Business as well as consumer confidence were low. And without optimism about the future, businessmen would not invest, and economies would not revive. Economies can reverse course quite suddenly, but for now the prospects of the West look bleak.

As world growth slumped in 2009, India’s growth also came down, but it was not due to transmission from abroad, but to India’s own cycle. The years 2005-08 had seen a spectacular boom in investment, which in turn had led to a boom in capital goods industries. This investment led industrial capacity to outrun demand by 2010 and brought down growth of investment as well as industry. What India experienced was a classic trade cycle. By the end of 2010, industrial growth was well below 5 per cent.

The deceleration in overall growth was much slower, largely because industry forms such a small part of our GDP now. Agricultural output was still growing rapidly; finance showed no signs of a slowdown. These divergent trends gave scope for divergent interpretations.

The prime minister’s economic advisory council faced a difficult task. It has taken upon itself the duty of cheering up the prime minister; it was not prepared to revise its optimistic forecast. But the fall in investment-GDP ratio stared in its face. So it brought down its 9 per cent growth forecast for 2011-12 to 8.2 per cent — lower, but still rosy. Unwillingness to face reality distorted its sectoral readings even more. It is clear that agricultural output has been growing rapidly in the past two years, and will maintain its growth this year. But the PMEAC settled on 3 per cent, which is taken conventionally to be the long-run agricultural growth rate. Manufacturing growth has slumped below 5 per cent, but that was too sombre for the PMEAC to face; so it settled on 7 per cent for 2011-12. Even that did not give it high enough overall growth, so it projected that trade and government would grow even faster. This optimism pervades the entire report. For instance, it was clear to the council that if Indian industry does badly, portfolio investment inflows must go down. So it raised its forecast of direct investment inflows. Even if the PMEAC tried to be realistic, it would be restrained by other incorrigible optimists in the government. For many years, P. Chidambaram used to predict 9 per cent growth whatever the reality; after he was removed from the finance ministry, the duty devolved upon Montek Singh Ahluwalia.

In my view, manufacturing growth is below 5 per cent and may be heading lower. So may be mining growth, which is below 3 per cent. Growth in trade and in construction is close to 8 per cent. It does not matter which sector: growth in all sectors is headed downwards. The only sector which shows high growth is agriculture; my estimate is 5 per cent. Overall, however, the trend is unmistakably downwards. That is for 2011-12; official optimists do not look beyond, but I see no reason for thinking that the downward trend will reverse itself next year. So we may be heading towards growth rates much below those we have seen in the last five years.

An intriguing feature concerns inflation; although growth is slackening under the influence of demand, inflation continues to be high. Officials seek fancy explanations such as that Indians have got rich and are eating more protein, whose prices are going up. They do get one factor right: world commodity prices have risen, and that has fed inflation at home. But though India has become more open, inflation here can never be explained in terms of international factors alone; its major causes will be domestic. And they do not change as long as policy does not change. They are the government’s fiscal deficits, which continue to be high, and its purchases of wheat and rice, clearly designed to raise their prices. Because of these policy factors, there is no organic connection between growth and inflation in this country.

The other mystery is the accelerated growth of exports and decelerated growth of imports in 2009-10. There was no external reason for this since the world economy was beginning to slump. My guess is that as domestic industry began to suffer from slackening demand and excess capacity, it sought relief by exporting and import substitution. Would the improvement continue? It could; I do not see an early end to surplus capacity. But it can be helped by policy; the government can depreciate the rupee. It has been suddenly depreciated by about 10 per cent recently. This is consistent with the Reserve Bank of India’s policy stance: it does not like to spend its foreign exchange reserves, so if there is pressure in the foreign exchange market, the rupee goes down. That happens once in a few years. But in my view, it should be built into policy. Given the government’s love of inflationary policies, long-term depreciation is indispensable; it should be engineered deliberately and systematically. China used depreciation to become the world’s manufacturing powerhouse. India may not be that successful, and manufacturing may not be its strength, but at least it should try. It would be even better for the government to rid itself of inflation addiction and foodgrain mania, but that is too much to expect of this government.