Challenges galore

For the new government

No one expects anything new on economic policy from the current sitting duck government. So, all attention is focused on the agenda for the next one. Many experts have expressed their opinion and some broad consensus is visible. Everyone of them emphasises the need for returning to the earlier 8 per cent growth path – in the interest of productive job creation for the new entrants to the labor force. All agree that the medium term prospects for India are good and despite the continuing global slowdown, a lot can be achieved by action on the domestic front.

The 101 economics course tells us that the primary requirement for high growth is high rate of savings and investment. If domestic savings are inadequate, we need to take the help of foreign savings to finance investment. Also, even with the same level of investment, more employment can be generated if the composition of new investment can be shifted from capital intensive sectors (like petrochemicals, automobiles, pharmaceuticals) towards labour-intensive manufacturing (simple consumer goods like textiles, apparel, footwear, toys, watches, low-end mobile phones).

What do official economists say? For example, ask Raghuram Rajan, the RBI governor. In media interviews, he has underlined four areas for attention (in his order of priority): physical infrastructure, better education for the workforce, regulatory reforms (to speed up clearance of projects, while respecting norms for land acquisition and protection of environment), and finance (even as RBI Gov, he considers this to be the least difficult in his list).

Though he does not (can not because of his official capacity?) suggest many specific policy measures, he talks about the need for fiscal consolidation (reducing subsidy bill by better targeting of subsidies), removing bottlenecks in the coal and power sectors (stopping short of suggesting the end of CIL monopoly in coal mining), using monetary policy to reduce inflation rate (which, he believes, will also serve to promote growth by reducing price uncertainty for investors) and maintaining a market-determined exchange rate (to sustain international price competitiveness of Indian products in the face of higher inflation rate in India) while intervening only to reduce excessive volatility.

Or Ask C Rangarajan, Chairman of PM’s economic advisory council. He points out that the overall investment rate has gone down from 32.9 per cent in 2007-08 to around 30.6 per cent in 2011-12. But even this lower investment rate should have given a GDP growth rate of 7.5 per cent (instead of the current below 5 per cent). So, the major culprit behind the sharp slowdown is due to projects not completed in time or lack of complementary investments (like in power and coal sectors).

Possible growthTherefore, if improvements can be brought about in clearing and implementing projects, in addition to removing bottlenecks in coal and power sectors, achieving a 7.5 per cent growth is possible even in the short run. The savings rate has fallen even more sharply, by some 6 percentage points over the same period. But the decline in investment rate has been less because of the help from foreign capital.

Thus, we would continue to need foreign investment to supplement domestic savings, apart from the role of FDI for bringing in new technology and helping exports by using brands and global marketing channels of foreign companies. Our problem is not too much FDI but too little. The fear of ‘crony capitalism’ dictating government policies is no less with domestic capital.

More than half of the 6 percentage point fall in savings rate is due to lower public sector savings. This emphasizes the need for reduction in fiscal deficit. Another area of concern is the sharp decline in the savings held in financial assets (and corresponding rise in gold and real estate).

The inflation rate needs to be brought down to discourage this trend. Rangarajan would also emphasize the need for reduction in the current account deficit of BoP to below 2.5 per cent of to prevent any further decline in the value of the rupee. A fall in rupee would increase the inflation rate (by making imported goods like oil more expensive in rupees) and push up the government subsidy bill for oil and fertilizers.

Coming to very specific economic reforms, some (mostly unofficial economists) would like to focus on labor market reforms making both hiring and firing easier. This, according to them, would encourage labor-intensive manufacturing in bigger sized organized firms reaping economies of scale, more exports and employment in these sectors.

But given the prospects of a highly fractured coalition government coming to power, the chances of such politically unpopular reforms being carried out by the new government are rather slim.

Finally, if growth picks up, the fiscal deficit problem would be automatically corrected to some extent by bringing in more tax revenue. But the inflation rate – specially the food inflation – is likely to get a boost. Monetary tightening is not going to have any impact on food inflation which is being caused mainly by a rise in the prices of non-grain agricultural products like vegetables, fruits, milk and poultry. The rise in incomes flowing from growth would further increase the demand for these superior foods.

Unless the new government can increase production of these types of superior agricultural products (a mere boosting of overall agricultural growth by more production of food grains would not do), the spectre of high food inflation would continue to haunt us. That perhaps would be the bigger economic (and political) challenge for the new government than rekindling growth.

(The writer is a former professor of economics, IIM, Calcutta)

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