India shows the way

World economy : Policy makers must focus on reducing the hassles of doing business in India, while raising real returns by keeping inflation low.

By now, it is universally accepted that India is the fastest growing big economy in the world today and is likely to remain so for, at least, the next couple of years. The most recent IMF report projects India’s GDP growth to be 7.3 per cent (in 2015), 7.5 per cent (in 2016) and 7.5 per cent (in 2017). The corresponding numbers for China are 6.9, 6.3 and 6.0.

As for the other BRICS nations, Russia and Brazil are projected to have negative growth in 2015 and 2016 (-3.7 per cent and -1.0 per cent for Russia and -3.8 per cent and -3.5 per cent for Brazil) while the figures for South Africa are 1.3 per cent and 0.7 per cent. India promises to be an island of stability amidst global turbulence.
The uncertainty for the global economy may arise from a number of sources. First, the slowing Chinese economy that is struggling to ‘rebalance’ from manufacturing, export and massive infrastructure investment to a more domestic consumption and service sector-based growth. This is adversely affecting the global demand and price of energy, metals and minerals.

The prices of such commodities are being further subdued as a result of continuing slowdown in the US, Europe and Japan, along with a big rise in supply of shale oil in the US and Canada with no offsetting cut from the OPEC and Russia. Sharply falling prices of energy, minerals and other commodities are causing negative growth for countries like Russia and Brazil and serious revenue and fiscal problems for major oil and gas exporting countries in West Asia, Africa, Latin America and Russia.

By the same token, the net importers like China, India, Japan, EU and the US are gaining and hence, the net impact on world demand may go either way. Nonetheless, the redistribution of global income on a big scale is sure to create a lot of uncertainty and dislocation.

For example, the declining economic fortunes for Saudi Arabia and the UAE would mean, apart from falling demand for imports from other countries (including India, a major exporter to the region), less investments in energy and infrastructure sectors in those countries, leading to lay off and fall in remittances for foreign workers and disposable income of families in their home countries.

The second type of uncertainty comes from the possible policy responses of the governments concerned and reactions of investors – both domestic and foreign. For instance, China may allow yuan to fall further (it is still a highly managed currency) in order to soften the blow to its exports and GDP growth. In that case, other competing countries will also go for devaluation of their currencies to maintain international price competitiveness, leading to a mini currency war.

The resulting uncertainty with respect to future values of currencies would put off foreign investors who may decide to move funds away from the emerging markets and into the safe haven options like the US dollar and gold. This flow of funds would depress the stock markets and the currencies of the emerging nations while strengthening the value of US dollar and gold. Rising dollar, in turn, may nip the nascent US recovery in the bud by causing a rise in US trade deficit.

For India, though falling oil and commodity prices are helping our balance of trade by cutting imports more than our exports (exports falling over the last 13 months in a row), the net outflow of funds from India (specially from the equity market) is likely to cause a rise in our overall balance of payments deficit and a further depreciation of rupee.

Moreover, the mere expectation of a future depreciation would induce investors (and even exporters and remitters of dollars from abroad) to postpone bringing money into India in the hope of a better rate in future. 

Third, the withdrawal of easy money policy in the US which has just started. Here, however, Fed is likely to go slow in raising interest rates, as the US recovery is still not firmly established and any sharp rise would cause a further appreciation of US dollar which would reduce demand for US goods and services. So, the global uncertainty from this front may not be significant.

Global political uncertainty

Finally, political uncertainty. The pro-xy war between Saudi Arabia and Iran has now come out in the open with snapping of diplomatic ties. The territorial expansion of IS in West Asia is likely to be halted by the combined air strikes by the western powers and Russia.

However, for the same reason, the  sporadic terrorist attacks by IS and other fundamentalists would increase in all parts of the world. This may not affect investment or economic growth in any significant way but the quality of life (including mutual trust, security and civil liberties) would surely be adversely affected.

Despite all the global uncertainties that may cause some headwinds for the Indian economy in the short run, eventually investors will return to India; to that extent the Indian growth story remains credible. Investors can not keep money in safe havens indefinitely  – they will ultimately invest their money where the risk-adjusted real returns are higher.

So, Indian policy makers must not lose this heaven-sent growth opportunity (caused by falling energy prices and slowing China) and focus on reducing the hassles of doing business in India, while raising the real returns by keeping inflation (specially food inflation which is the major trouble spot) low and enhancing the productivity of workers.

This would require institutional reforms, infusion of superior technology and investment in agriculture to improve supply responses in non-grain food articles (pulses and oilseeds, in particular) and shifting government expenditure from unproductive subsidies (including ever increasing privileges for government officials and politicians) to investment in infrastructure, education and health.

(The writer is former Professor of Economics, IIM Calcutta)