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Issue No.: 561 | March 2014

Reflections on India’s Continued Economic Drift

Sunil S. Bhandare
Old Mother Hubbard
Went to the cupboard
To get her poor dog a bone;
But when she came there
The cupboard was bare,
And so the poor dog had none.

What is the chaotic "new normal” of the current Indian political scenario? This question reminds me of a very fascinating presentation on "Surviving in the VUCA Environment”, which I had the benefit of listening to just a few weeks ago. The acronym stands for volatility, uncertainty, complexity and ambiguity. This was meant for those engaged in strategic business and corporate management. Let us flip this acronym to focus on our prevailing political situation, which is increasingly becoming Vulgar, Ugly, Confrontationist and Antagonistic. We, the people of India, are in a state of deep distress and anguish by what we are seeing during the last session of the 15th Lok Sabha. And the challenge for us is how to survive in this VUCA political environment!

This little backdrop is perhaps necessary to understand the ongoing economic drift, which is attributable to the collapse of political governance over the past several years. But as is their wont, neither the Prime Minister nor the Finance Minister would ever be tired of reassuring us that thanks to their efforts of the last 18 months, the economy has stabilized and the next government that will take over after the 2014 general elections to the Lok Sabha due in April-May would be able to build on this platform. But is it really going to be so?

Sources of Comfort

One can see significant sources of comfort on two counts: first, the impressive agricultural recovery (estimated growth of about 4.6% in 2013-14); and second, the restoration of relative external sector stability. Indeed, this strong agricultural recovery has helped in averting further economic drift and salvaged to some extent the overall growth performance during the current financial year. But this is entirely fortuitous and has nothing much to do with any of the government’s policy. It has everything to do with a good monsoon and an impressive turnaround in  the external sector clearly visible in (a) a projected sharp  reduction in current account deficit to GDP ratio to about

2.5% in 2013-14 as compared to 4.8% in 2012-13; (b) shoring up of forex reserves by over US$17 bn. (from the low of US$275 bn on September 6, 2013 to over US$292 bn now); and (c) recovery in the exchange rate – the rupee  appreciating by about 6.5% vis-à-vis the US$ since end- August 2013 after its sudden sharp depreciation by about 20% during the previous short span of four months. But, for this, we have to compliment the RBI more for its prompt and competent management of monetary and exchange rate policy rather than the Finance Ministry. Indeed, the latter’s fiscal consolidation effort as well as the overall inflation control initiatives of the UPA II government in general, leave much to be desired.

In contrast witness the negative factors and sources of economic instability. And they overwhelmingly manifest in (a) relentless high inflation; (b) continued drift in the real GDP growth rate; (c) prolonged industrial stagnation; (d) rapidly falling investments; (e) failure to generate adequate employment opportunities in the formal sector (e) uncertainties of overall economic policy environment; and (f) overall loss of consumer and investor confidence.

Stagnant Growth Performance

However the most worrisome – and in a sense the ultimate indicator of the performance of the UPA government – is to be found in the trends of the national accounts data. It is official now: India’s real GDP growth rate would be less than 5% (4.9% to be precise) in the current financial year though some of the key spokespersons of the Government, especially the Finance Minister, would like us to believe that the revised figures, as and when the same are available in the latter half of 2014-15, would show real GDP growth rate higher than 5% in 2013-14. A proverbial Tweedledum and Tweedledee syndrome! The fact of the matter is that the economy has been stuck in the groove of low and stagnant growth for a fairly long time with no immediate prospect of a bounce back as the table below indicates:

Sectoral Annual Growth Rates (%) 2010-11 2011 -12 2012 - 2013 2013 - 2014
1. Agriculture 8.6 5.0 1.4 4.6
2. Industry  7.5 7.8 1.0 0.7
     of which Manufacturing  8.9 7,4 1.1 - 0.2
3. Services 9.7 6.6 7.0 6.9
Real GDP 8.9 6.7 4.5 4.9

In this context, the key worrisome features of macro economic growth indicators are:

  • The adverse impact of policy paralysis of the last about three years now manifesting in virtual industrial stagnation and negative growth rate, albeit marginal, in the manufacturing sector after over two decades. The previous negative manufacturing growth (-2.4%) year was 1991-92 – the year of economic crisis as well as of reforms. The industrial sector then was reflecting the adverse impact of fiscal compression, stringent monetary policy and sharp devaluation of the Indian rupee. Most of these conditions happen to be almost similar during the greater part of 2013- 14, except that there is no economic crisis per se!

  • Global factors – haltingly slow global economic and trade recovery – contributing to manufacturing contraction, though in a small measure. If the domestic  policy environment, which is inextricably linked with the outcome of forthcoming general election in May 2014, does not improve, the chances of economic recovery very poor.

  • There is a continuing set-back to gross domestic capital formation [GDCF] in the economy. The CSO data reveals investment rate or GDCF/ GDP ratio  (measured at current prices) has declined sharply from 34.3% in 2012-13 to 32.3% in 2013-14. The best investment rate was at 38.1% in 2007-08. This loss of  6.2% points in investment rate [GDCF/ GDP ratio]  means about 1.5 percentage point erosion of future growth potential of the economy.

In effect, India has lost not only its future potential growth rate [due to the falling investment rate], but is also performing well below its current true potential. Even with the current investment rate, it should achieve real GDP growth of 7.5% plus, if capital  resources were to be optimally and efficiently utilized. But we have allowed large public sector wastage, build up of unutilized capacities [both in public and private sectors] and accumulation of non-performing assets. Thus, our incremental capital output ratio has been severely impaired in recent years. In no small  measure the UPA II government is responsible for this predicament.  Perhaps the most worrisome feature of macroeconomic parameters is the shrinking of financial savings to GDP ratio. And the main contribution for this fall is the collapse of the household sector’s financial savings – attributable to (a) diversion of its savings to physical assets like real estate and gold; (b) erosion in its capacity to save due to persistent high inflation; and (c) inadequate employment growth, especially in the formal sector.

Looking Beyond 2013-14 

In summing up, the UPA II government is certainly not leaving the legacy of a healthy and stabilizing political economy for the next government. If were it to be so, it could as well have aspired to return to power to form the UPA III government! On the contrary, apart from drifting  growth performance, the next government would be confronted with huge tasks of steering growth with stability. And the toughest of them all would be the challenge of restoring the quality of fiscal management. The incumbent Finance Minister can, no doubt, be expected to proclaim that he has managed to contain fiscal deficit to GDP ratio at 4.8% [or a shade lower] in 2013-14. But quantitative fulfillment of fiscal target would conceal the huge  qualitative impairment of budgetary management. The true spirit of fiscal consolidation has gone for a toss – witness his desperate attempts to sponge on surpluses of profit-making healthy PSUs, including the RBI.

Indeed, social sector expenditure extravaganza has been the hallmark of the UPA II regime; valuable budgetary resources have been channeled into misdirected subsidies and other non-plan, non-developmental expenditures. Witness its recent populist initiatives, which cover a wide spectrum of activities from enhancing the household quota of subsidized LPG cylinders to reducing prices of CNG and piped cooking gas supply; continuation of interest rate subvention to farmers, prompt release of DA payments and liberalizing PF benefits to its own employees, constitution of the 7th Pay Commission, et al.

The next government will have to face massive problems arising from the erosion of both fiscal discipline on one hand and loss of financial savings capacity of the economy on the other. In other words the new Finance Minister will, in all likelihood, find the coffers almost empty. 

SUNIL S. BHANDARE is a Consulting Economist based in Mumbai. 





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