Prime Minister Narendra Modi’s first year in office has evoked mixed reactions. While there is a consensus that he has done well in foreign policy, there is a growing feeling that he has not lived up to his promises at home. Nowhere is the disappointment more palpable than in his failure so far to revive the economy. Manmohan Singh’s government had allowed growth to drop sharply from more than 8 per
cent a year to 5.5 per cent (2004-5 series), industrial growth to fall from a nine-month peak of 14.5 per cent in 2009-10 to below 1 per cent and employment to virtually stop growing. Every year, therefore, around six million young people who would have found jobs easily had growth not faltered found themselves facing an uncertain and impoverished future.
The collapse began in 2011, the same year that China’s fiscal stimulus ended and its economy too began to slow down. But while a large part of China’s slowdown occurred because deepening recession in the industrialised countries curtailed the growth of its exports, in India, the slowdown was largely self-inflicted, for it arose out of an attempt by the RBI to control a cost-push inflation by curbing demand. From 7-8 per cent in 2006, average borrowing rates climbed to 13 to 14 per cent at the beginning of 2014 .
The result was stagflation. The construction industry, India’s main job generator, went into a coma, and the consumer durables industry was almost wiped out. When inflation did not come down even after three years of high interest rates but jobs became more scarce, people
lost faith in the Congress and switched allegiance to the BJP.
Modi rode to power on a promise to restore growth rapidly, and it is not that he has not tried. In the past year, the government has enacted a slew of reforms in the product and factor markets that will improve the climate for investment, and smooth the future growth of the economy. But these reforms have done nothing to remove the two main roadblocks that have stalled growth. The first is the non-availability of land. The second is an acute shortage of investment.
The paucity of land has arisen from the refusal by every government of the last 60 years to admit that in a democracy, where landowners have the right to move the courts, people must be persuaded, not forced, to part with it. Modi’s government has proved no more enlightened than its predecessors.
The shortage of capital to finish stalled projects and finance new ones arises not from a dearth of savings, but from investors’ unwillingness to invest in India at these high interest rates. Infrastructure projects have been the worst hit because a 12 per cent interest rate adds 40 per
cent to a five-year project, 70 per cent to an eight-year project and more than 100 per cent to a 12-year project, such as a hydroelectric power complex. This virtually guarantees their insolvency even before they go on line.
The high borrowing cost is a direct consequence of the RBI’s obsession with controlling inflation by raising interest rates. This policy dates back to 2007 but has been turned into a religion by current governor Raghuram Rajan, who has turned a deaf ear to every entreaty to lower interest rates, claiming that he is still not convinced that inflation is really over.
To say that this has been suicidal would be an understatement, for it has made Indian private companies forsake India to invest abroad, and state-owned enterprises park their money in banks where they earn a safe 7 to 8 per cent a year. Since 2007, the former have invested well over $60 billion in ventures abroad and next to nothing in India. As for the latter, on April 1, 2014, they were sitting on $110 billion (Rs 6,89,000 crore) of idle reserves at home. Had the bulk of these reserves been used as promoters’ equity in new projects, it would have triggered up to $600 billion of investment by now and our infrastructure famine might have been history.
What India needs is an interest rate policy geared towards promoting growth, not fighting inflation, and a commitment to fight demand inflation, should it recur, by reducing government spending. Ideally, borrowing rates should be brought down not by 0.5 or even 1 per cent, but by 5 per cent over the next year, till they are at most 1-2 per cent above the rate of inflation. This is no longer just an economic imperative but a political one, for the BJP’s honeymoon period is coming to an end.
Jha is a senior journalist and author.