Monday, June 4, 2012

Government Still Considers POISON as AMRIT to Cure Sick Economy


Government has to have an investment-driven strategy to boost growth

The weak GDP growth of 5.3% year-on-year for the quarter ended March 31, 2012, was a major downside surprise. Despite weakening growth, headline wholesale price index ( WPI) inflation remained at a significantly higher level than the RBI's comfort zone. 

The data confirm

s our view that India is now in a stagflation-type environment and we expect this environment to persist over the next two to three quarters. 


Even as we expect GDP growth to remain at sub-6% levels, inflation is likely to remain above 6.5-7% over the next few months. This is diametrically opposite the high growth-low inflation environment of 2003-07. 

How did we get here? An adverse global environment in the form of weak global capital markets and relatively high oil prices has contributed to the weak macro environment. 

But we think the domestic policy environment has been a more important contributing factor. Over the last four years, the government has been relying on a bad growth mix, characterised by a high level of national deficit in the range of 9-10% of GDP (excluding one-off telecom revenues), while private investment (as a percentage of GDP) has been declining steadily. 

A number of factors are liable for the weak domestic policy environment. First, national savings have declined by 6.4% of GDP from FY 2008-12 primarily due to higher government deficit. This, in turn, has become the key constraint to investment growth, slowing the pace of capital accumulation and attendant productivity boost. 

Second, some of the policy decisions have not only resulted in higher deficits but also distorted productivity. For instance, the national rural employment scheme has been one of the key factors pushing rural wages up without matching gains in productivity. 

This scheme has had a significant negative externality on rural labour supply and demand. 

Third, a systematic slowdown in administrative decisions has slowed the process of harnessing natural resources and overall investment project-related approvals. Fourth, a delay in implementing indirect tax reforms. 


Tough, not austere: Anaemic expenditure cuts will achieve nothing, we need bold reforms

The government is reportedly preparing for a 10% cut in non-Plan expenditure. These kind of rituals will serve very little purpose. To make a real difference either to government expenditure and borrowings or to public confidence in the government's ability to make an impact on the economy, we need something more than a little cutting, pruning and flower arrangement. 

Gross fixed capital formation is sharply down, from a peak of 38% to below 30% now. But it is not just investment that is down. Consumption has also slumped, from the traditional close to 60% of GDP for the non-government sector as late as in the first quarter of 2011-12 to a lowly 52.2% by the fourth quarter. 

This is a double whammy. What can sustain economic activity if both consumption and investment dry up? People are hoarding their savings as gold and silver: a completely unproductive form of storing value for the economy as a whole. 

There have to be proactive measures to kick-start investment, restore consumer confidence and access to financial savings, stabilise inflation so that banks start lending and consumers start spending. 

Acting on the fiscal deficit is a key task. While the size of the fiscal deficit is an issue, what these borrowings, which appropriate the private sector's savings, are used for is even more important. 

If these are used to subsidise consumption, the result is egregious. And that is precisely what the government does with its plethora of subsidies and transfer payments. The most sensible subsidies to cut are the open-ended ones on fuel and urea. 

These are counterproductive, dictated by global crude price movements and of relatively minor benefit to the individual recipient. But removing these subsidies calls for political courage of a high order. If the government musters that courage, it will both improve the quality of government expenditure and restore investor confidence. 

Along with measures to speed up clearances of all kinds, a display of political will to take tough decisions will bring investment back. Investment in rural supply chains will do a lot of curb inflation. The point is to act, not stop short at feeble announcements.

No comments:

Post a Comment