Defying slowdown: Time for a holistic approach

The overall index of industrial production (IIP) in India had risen by 8.2 per cent in October 2012 when compared to the same month last year, according to the recent estimates of Central Statistics Office (CSO).

But most analysts are of the opinion that this may not be seen as a sign of recovery. The most recent growth data released by CSO shows the growth rate of the second quarter of this fiscal (July-September 2012) at 5.3 per cent.

The fact that this is the third consecutive quarter in which the GDP growth rate has hovered around this rate forces one to conclude that the budget forecast of 7.6 per cent growth rate remains to be an elusive dream.
The growth rate for the year ended March 31, 2012 was 6.5 per cent as opposed to the earlier projection of 6.9 per cent.

The consensus opinion among economic pundits is that the current fiscal will record the lowest annual growth rate in well over a decade. They also forecast a fiscal deficit of 6 per cent this year, though the government promises to keep it at 5.3 per cent of GDP.

This steep climb down from the 9 per cent growth rate achieved in the three years preceding last fiscal is characterised by a decline in growth rates in almost all sectors of the economy including agriculture, manufacturing, mining and construction.

The mining sector registered a negative growth at 0.9 per cent in 2011-12 against 5 per cent in 2010-11. The manufacturing output slowed to 2.5 per cent from 7.6 per cent in the previous fiscal.

There has also been a decline in investment levels and consumption levels. Consumption expenditure as a percentage of GDP came down to 52.2 per cent in the fourth quarter of last fiscal from 60.4 per cent in the same fiscal. The growth trend of the economy was characterised by high inflation, high level of fiscal deficit and current account deficit.

Most analysts opine that the government’s inaction and policy paralysis are the major reasons for the current predicament. High interest rates have hit housing and infrastructure projects. Interestingly, these are the sectors with the maximum multiplier impacts that can boost economic performance and productivity.

To contain inflation, RBI hiked interest rates 13 times, raising the cost of capital and hindering growth, but inflation has not come down. There has been notable inertia on the policy front and continued failure to address fiscal imbalance. A high fiscal deficit built up by the government has crowded out the private sector.

The combination of low growth and high inflation can weaken the economy further. Slower growth can lead to unemployment, sluggish tax collections, stressed government budgets and flight of capital.

There should be a focus on reforms and governance aimed at revival of growth. What is required is a holistic approach and not a mere macroeconomic policy management influenced and conditioned by the political environment. This needs structural reforms both at the central as well as the state levels. Fiscal deficit must remain at the budgetary level.

The main reason for the unprecedented depreciation in the value of the rupee was the inadequate capital inflows to cover the revenue account deficit. We must encourage capital flows and the sentiment for that has to be created.

The government msut take measures to address business and consumer sentiment. Supply side reforms should be preferred since there is only limited scope for a demand side fiscal stimulus due to the already high fiscal deficit.

Though the government signalled its determination to pursue pending economic reforms including FDI in multi-brand retail and civil aviation and the partial phasing out of fuel subsidies, the impact of these may not influence the economy this fiscal.

The austerity measures like banning the creation of new Union Government posts and asking all Union Government departments to cut down their non-plan expenditure by 10 per cent cannot help much. Opening up of multi-brand retail to foreign direct investors will have only limited impact.

As Sunil Sinha, the principal economist at Crisil, recently stated, “External stimulus to India’s growth story certainly doesn’t exist. We have to rely on domestic measures and domestic growth story.”

What is needed most urgently is an investment revival. The national investment rate continues to decline. Getting investment activity back on track is perhaps the most important macroeconomic challenge.

On an emergency basis, the government should restart stalled projects. Sectors with maximum multiplier and linkage effects like roads and housing should be preferred. This can generate more employment and raise effective demand in the economy.

It should be understood that the most significant sources of economic growth are saving and investment in new capital, the growth of human capital, and the invention of new technologies. In order to make progress in the right direction, economic policy needs to stimulate saving that finances investment and in turn brings capital accumulation that drives economic growth. A holistic fast-track reform process is imperative to drive growth.

(The writer is professor of economics at Christ University, Bangalore)