Millennium Post

Alarm bells are ringing for the economy

India’s economy is now faring worse than during the global financial melt-down of 2008. That speaks a lot about the reverse turn in the fortunes of Indian economy in a short time. It reflects the policy drift that we have been witnessing for the last couple of years.

Thursday’s release of the GDP growth number for the last quarter of 2011-12 shows the last quarter growth to have come down to just 5.3 per cent. What a contrast! When the finance minister, Pranab Mukherjee, presented his budget for 2011-12, he had presumed a growth rate of 9 per cent for the economy. With the latest quarterly figure, Indian economy will have grown by just about 6.5% in the whole year. No wonder that the finance minister’s budget figures had all gone wrong for the last one year as the underlying growth assumption had proved to be highly inflated.

The growth figure had belied the expectations of the Reserve Bank as well. In its latest statement, RBI had observed that low growth had bottomed out by the third quarter of the year and RBI expected fourth quarter growth to come closer to 7%. What has happened is a clear 2% lower show. The financial markets had also expected far better performance and there will be another round of slide in the markets.

Although the figures are disappointing, these are not the real concern. Indian economy has the potential to grow faster and growth rate can pick up momentum. But these figures also are the result of the policy drift we have been going through. There are two issues here: first, Indian economy is showing some structural rigidities which have to be overcome. Secondly, the recent policy drift shows a mind-set, it is far more difficult to overcome these than some mere dip in numbers.
Let us look at the structural rigidities first. We have been seeing that there is a mismatch between demand for food articles and their supplies. While foodgrain production has scaled new heights - 250 million tonnes - the demand for vegetables and protein items are shooting. As a result, foodgrain is overflowing and there is hardly any infrastructure available for their storage. Vegetable prices are periodically soaring and there are hardly any back-end facilities available for their storage and transportation to ultimate consumption points.

The mismatch and the surging food articles prices is the Achilles heel of the Indian economy as price spurt has been duly followed up by the RBI with nearly two years of interest rate hike, no matter how infructuous it was in controlling prices. As interest rates were raised, prices went up in step. However, no notice was taken by the RBI in pursuit of the strictly monetarist view of anti-inflation battles.

The end result of this single minded policy was deep slow down in the industrial sector. As the disaggregated quarterly growth figures show, throughout the last one year, industrial economy skidded across the board. Mining and quarrying went into negative zones, so also manufacturing and electricity generation, which had otherwise shown robust rends, went down as well. The slow-down in the industrial economy set the pace of the downward spiral.

Underlying all these developments was a deep drop in investment in the economy. This was noted by the Prime Minister’s Economic Advisory Council in its February report as well. It was pointed out by industry as well and the trend was confirmed by various business confidence surveys. What else can happen to investment when interest rates were successively going up to intimidating levels?

The second structural rigidity was in the balance of trade. Over the last one year, trade deficit has increased to unsustainable levels and these could cause a serious external payments problem unless taken care of. Trade deficit touched $185 billion when inflow of funds from overseas was slackening. The current account deficit – that is, offsetting the trade deficit from capital receipts - also kept on increasing and now touching the danger mark. Last year end, to meet trade deficit, funds were drawn from foreign exchange reserves.

Huge demand for oil and increasing gold imports – two largest import items - were causing pressure. Besides, with shortages of industrial raw materials, these imports were also rising adding to the import bill. Consider the contrast: while India has world’s third largest coal reserves, coal imports were rising and the Planning Commission was working for import of 250 million tonnes of coal by the terminal year of 12th Plan.

These structural rigidities will have to be addressed if India has to maintain the growth story. But then, if you question why these are not being tackled, we come to the policy mind-set. To address these structural problems, Indian policy makers have to take five principal steps.

First, to take care of the farm economy mismatch, India must develop at this point its horticulture sector and develop throughout the country post-harvest infrastructure. These involve putting up massive grain storage facilities, cold chains for storing vegetables and fruits, meat and poultry items, dairy products. Additionally, distribution chains, involving investments in refrigerated vehicles and market level infrastructure spread across the country will have to be put up. This calls for huge investment in such facilities.

Such modernisation of farm economy and food items distribution chains could have been easier by allowing global food retailers into the country. The global food chains have the necessary technology, management expertise as well as money for building such back-end infrastructure. However, the small policy change required for admitting global food chains into India could not be implemented even after the policy was announced by the government for no other reason than headstrong opposition from the government’s coalition partners.

Secondly, policy paralysis over industrialisation is holding up all investments in basic and core industries as well as downstream units. Consider for a moment that coal mines could not be opened for want of land as well as because of environmental clearances. Proposals for large steel plants could not be taken up for opposition to land acquisition for such units even when these are not infringing upon forest land or tribal land. The land acquisition policies followed today are such that if these were the norms, none of our so-called temples of modern India – steel plants and other public sector units - could have been set up.

Thirdly, we need to be pragmatic about costs and their recoveries. We cannot go on selling oil at less than landed import price. Such policies result in utter misuse of resources. These policies contribute to making the fiscal situation increasingly imbalanced.

Fourthly, we are pursuing policies as if to penalise successful industries. If senior ministers in the government have committed irregularities, is it fair to penalise overseas investors who entered the country on the presumption that since government had taken decisions these are above board. Is trust in the decisions of the government of India among overseas investors is their fault? Should their investments be at risk?

Fifth, we are taking policies in isolation. How can the finance minister introduce retrospective taxation without giving a thought as to how the proposal will affect investor sentiment. If some ill-advised taxation treaties had provided for aggressive tax loopholes, can these be reversed with back dated effect at the whim of the finance ministry? Yes, plugging loopholes for future is paramount right and should be done. But a government cannot commit fiscal anarchy.
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