Indian economy: Despite some success, problem areas remain

With a new government at the helm, India is about to complete the year 2014. International institutions like IMF expect a pick up in the growth rate of GDP somewhere in the range of 5.5 per cent in 2014-15 and above 6 in 2014-2015.

But some major problem areas remain. Agricultural growth is going to be subdued due to less than normal monsoon. Thankfully, agriculture has a weight of only around 15 per cent in GDP – so its drag-down effect on GDP would be low. Services having the maximum weight, presents a mixed picture. Manufacturing, despite showing some signs of recovery, is yet to show stable health, specially because the big stalled projects carried over from the last regime have not yet kick-started. If and when that happens, the so-called virtuous investment cycle would hopefully resumes.

The real good news is on the inflation front.  After 5 years of high inflation, the CPI inflation – a better indicator of popular concern than the official WPI inflation - has come down to below  5 per cent while the RBI’s  declared comfort zone is 4 per cent, plus/minus 2 per cent.  This is mainly due to international factors and sheer good luck. Both international energy and commodity prices (including food and edible oils) have fallen significantly – specially the price of crude oil.

Through successive hikes in MSP for agricultural products under the earlier regimes and the recent fall in international prices, the gap between domestic and international prices of many products have considerably narrowed. That means the pressure to raise MSP would be correspondingly less.  Also, exports of agricultural commodities from India at international prices would not lead to any significant rise in domestic prices.

At the same time, there are no noticeable initiatives or improvements on the domestic supply side of agricultural products – specially non-grain food articles like vegetables, fruits, eggs, fish and dairy products where the bulk of food inflation has originated in recent times. With the resumption of higher growth and incomes, a rekindling of food inflation remains a real possibility.

About 90 per cent of the fiscal deficit target of 4.1 per cent has already been reached. Hence, keeping to the target would require   substantial pruning of  both capital and consumption expenditures of the  government and garnering PSU disinvestment proceeds, spectrum and coal auction revenues in the remaining few months of this fiscal. Despite the formation of the Expenditure Commission in the last budget, no new policy proposals for cutting down subsidies have come out in the open.  

The respite on the fiscal front has come from the luck factor of sharply falling oil prices and stable rupee which have reduced the oil and fertiliser subsidy bill of the government. This has enabled the government to decontrol the price of diesel, a long-standing item in the reform  agenda. Falling oil prices has also allowed the government to impose some additional taxes on oil products without pushing the inflation rate.

The direct cash transfer of subsidies  by linking Aadhaar to bank accounts which the Modi government is pushing vigorously, despite its initial reservations, would go some way in further cutting down the food and oil subsidy bill by eliminating at least the fake and duplicate beneficiaries. However, by itself, it would not adequately address the issue of subsidies going to the non-deserving. The deadline for introducing GST is being pushed back all the time on some pretext or another. The current account deficit of balance of payment (BOP) has come down to a sustainable level of below 2 per cent of GDP which can be financed by stable inflows of foreign capital.

In fact, despite the CAD, the overall BOP has shown a surplus due to capital inflows, leading to a rise in forex reserves to a comfortable level of over $310 billion. The rupee, following the free fall when Raghuram Rajan took over as RBI governor, has stabilised at around Rs 62-63 to a dollar. With Indian inflation coming down, the chances of a further big slide down of rupee are not high for the near future.  However, despite some signs of recovery in US, the lingering recession in EU and Japan would act as a dampener on the export growth of India.

The RBI is still not willing to lower its guard on the inflationary dangers and is postponing the anticipated repo rate cut, notwithstanding the plea of the business and the government to start monetary easing. RBI believes that controlling inflationary expectations is vital for investment and growth, and thus there is no conflict between the goals of inflation control and stimulating growth.  

Investment and growth

In any case, a small cut in policy rate would have a negligible effect on new investment and growth. At best, this would reduce the interest costs of existing companies, boost their bottom lines and give a fillip to the stock market. But the binding constraints on new investment expenditure   continue to be the difficulties of doing business in India like problems in land acquisition, unreliable coal and power supplies, unstable tax regimes and delay in securing environment and other clearances from the government at different levels.

Unless those issues are tackled, monetary policy can do little to take India to a sustained higher growth trajectory. Nonetheless, easing of monetary policy may start early next year, if the downward momentum in inflation continues. A new worrisome feature is the attempt to push the aggressive Hindutva agenda by some members of the Sangh Parivar which has the potential to take the focus away from the development agenda of the Modi government.

Nothing can be more unfortunate than this, given the high expectations that a vast number of people – in India and abroad - had from the new government which, for the first time in many years,   is free from the compulsions of coalition politics. At the same time, in principle, it may be easier to control these fringe elements with BJP in power than in the opposition.

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