Hubris and the Falling Growth Story
The premonition of elections prompts grand claims by members of the political class. Thus the Aam Aadmi Party had promised free water while Narendra Modi has promised bullet trains. The Congress has taken a different tack with one of its leaders claiming that the party has given India the ten best years ever in its history. Perhaps, being the incumbent the party cannot only make promises, it must account for the term being completed. With two consecutive terms, it has had a longer innings than any coalition has been given during the past thirty five years.
As the claim is about the economy it comes as a surprise, for it is over the past decade that the Great India Growth Story which had made the country the cynosure of eyes, and which had actually commenced before UPA I was in place, began to flag. Today, compared to Year 1 of the coalition the economy appears somewhat the worse for wear. Inflation has raged unremittingly for three years now, the balance of payments had come under stress four months ago, and the growth rate has halved since 2008. If growth and inflation are the macro-economic indicators by which we are to judge an economy’s medium-term performance, what we have witnessed is a sommersault, with double-digit growth being replaced by double-digit inflation. Frankly, there never was achieved double-digit growth. There had only been the promise of it. But one thing is clear. Economic performance in the past decade cannot really count as satisfactory, leave alone the best that India has had in recent times. The far more interesting question is how it came to be that having been cruising on the turnpike we are now reduced to chugging along what feels like a gravel path.
The best description of the turnaround would be ‘implosion’ as the situation has been brought about by economic policy itself. We are able to see from the Government of India’s Economic Survey for 2012-13 that over the period 2010 to 2012 growth in India has slowed more than it has in most of the major economies of the world. Significantly, it has not slowed in the US. Further, of all the countries included in the Survey’s graphics, India has the lowest share of foreign trade. So, it appears reasonable to conclude that the slowing of growth in India is related more to internal rather than external factors.
As part of the process of arriving at what factors are at play we might begin by looking at the recent history of exports and foreign direct investment (FDI). Export growth did show a decline shortly after the onset of the global financial crisis, but has been substantially higher in all but one year since 2007-08, the year in which growth had peaked at close to 10 percent. This was also the year in which the financial crisis developed in the United States before spreading around the globe. As for FDI, while the rate of inflow may have fluctuated from year to year, the inflow has been higher in every year since 2007-08. In some years it increased by over 30 percent. So we find that neither exports nor FDI are likely to have caused the slowing of growth in India. We are now left firmly on home ground, so to speak, in our search for what underlies economic performance in India over the past five years. The picture is complex as there are several factors at play. However, even though we may be in a position to account for the impact of each, it makes sense to focus on the principal ones. Firstly, mid-way through the last decade, in 2008-09 to be precise, there was zero growth of agriculture. This was followed by a year of anaemic growth leaving output yet below its trend. This development triggered off an inflationary process that is yet to subside. But the actions of the government are egregious in their role in having aggravated an already bad situation. Farm support prices have been raised despite food stocks much higher than the government-designated buffer-stock norm. In this scenario there was no let up in the rise in prices. This also coincided with the introduction and gradual spread of the NREGS. Rural wage growth quickened, adding pressure on food prices. Food constitutes a ‘basket’ wider than the cereals the prices of which government determines, and the combination of poor agricultural growth, the Sixth Pay Commission salary hikes, and the NREGS have created a permanent excess demand for food. The inflation has, at least in part, been the result of the government trying to shift the terms of trade towards rural producers.
Having to some extent contributed to, if not actually engineered, a higher inflation rate the Finance Ministry turned to Mumbai for action to control it. A trigger-happy RBI, conscious that inflation control is perceived as its raison d’etre, got into its stride. Now, mid-way through UPA II it raised the policy interest rate 11 times in succession. This did not curb the inflation. But it had a negative impact in another sphere. It succeeded in bringing manufacturing growth almost to a halt. Inflation driven by supply-side factors, whether in the form of a government raising support prices or of a slow-growing agricultural sector cannot be cured by monetary policy. Therefore, India’s central bank would be more socially productive if it listened to the repeated concerns over rising interest cost brought up by industry associations than to its own mantra regarding inflation control. Here, it would be germane to contest the RBI’s suggestion that inflation is due to the central government’s a fiscal deficit. While it is true that the fiscal deficit is higher after Mr. Mukherjee’s stimulus package, it has been declining steadily as share of GDP. It is by now close to 30 percent lower than it was at its peak in 2008-09. It cannot be said the economy is over-heating.
Actually, far from having overheated the economy via its actions government has very likely contributed to its cooling. This it has done by allowing public investment to decline steadily after 2009. As a share of GDP it is by now lower than it was in 2007-08, the year in which the growth rate had peaked. This is also one reason for declining private investment, which moves in tandem with the public. In this trajectory of public investment we find a clue to the unraveling of the India growth story. Over-confident having come close to breaching the double-digit barrier, UPA II took its eye of the ball of growth. If a government spends all its time devising the next rights legislation or imagining yet another welfare scheme it cannot but give less attention to the productive side of an economy. The high growth of UPA 1 was accompanied by a record rise public investment in infrastructure. It is important to state here that this commenced only under the UPA, public investment having been steady under the NDA. Public investment in infrastructure actually starts declining, though mildly, from around 2009-10. This could not but lower growth.