Economy on autopilot? Not quite

This is particularly impressive because, in what tenure remains of this government, nobody seriously expects any reform initiative, whether in pension, insurance, finance or labour. Clearly, the momentum achieved is adequate to sustain projected GDP growth.

Nonetheless, there are serious concerns deserving policy priority.

First, we must recognise that India has become increasingly integrated with the global economy. Trade as a percentage of GDP has risen from 14.6 per cent in 1991 to 35.9 per cent in 2007. Exports, inclusive of services, have risen from 5.8 per cent to 15 per cent.

Given the current turmoil in financial markets, the incomplete unwinding of sub-prime markets in the US, and its likely contagion effect beyond the housing sector, a slowdown in the US is a distinct possibility. It is still debatable whether the somewhat strident steps by the Fed to lower the prime rate by 50 basis points can stabilise markets, infuse renewed confidence and rebuild the risk propensity in view of the recent experience. All this is too early to predict. A significant slowdown in the US economy will definitely hurt India’s exports to the most prosperous market. Coupled with this, the persistent weakening of the US dollar against all major currencies and the rupee will put increased pressure on the competitiveness of our exports.

Further the reduction in US interest rates is expected to generate large capital flows to emerging markets, particularly China and India. The Indian economy continues to out-perform many others and these anticipated flows will inevitably put pressure on the exchange rate, making some appreciation of the rupee inevitable. The extent to which productivity and efficiency gains by exporters, with no significant innovation round the corner, can compensate for a rising rupee remains debatable.

Rigid labour laws circumscribe room for manoeuvre. The RBI will have little option other than a more aggressive sterilisation along with a reassessment of our monetary policy. The pronounced sluggishness in export will hurt GDP growth, export earnings, and export-dependent employment since a significant part emanates from labour intensive activity as well as from the small and medium sector. The RBI, at the same time, will consider the risks of inflationary resurgence, given the hardening oil and food prices, incipient fiscal concerns for an appropriate balance in the pursuit of inflation and growth. Besides, India was not a significant player in what Alan Greenspan in his book, The Age of Turbulence, describes as the end of a disinflationary era, given our labour policy inflexibilities.

Second, given current revenue buoyancies, the fiscal and revenue targets for the current year may be substantially realised, but this masks several deficiencies, most important of which are the large under-recoveries in the petroleum sector (given the politics of energy pricing), under-payment for fertiliser subsidies and a much higher food subsidy bill with a significant rise in food-grain prices due to global production shortfalls. Add to it, the contingent liabilities from the possible fallout of the interim recommendations of the Sixth Pay Commission and other populist expenditure pressures and the overall fiscal picture begins to look less rosy.

Third, there is no appetite to rekindle the stalled reform process. This is true even in areas where mere administrative action is needed. Thus progress remains tardy.

At the recent Dalian conference sponsored by the World Economic Forum, there was a recurring theme on ‘Growth Hotspots’. There was separate focus on India, Japan and China. On India, there was a general consensus that the hotspots will be the more vibrant states where a combination of improved governance and investment seeking will foster competitive federalism than competitive populism. In the context of Japan, Heizo Takeneka, a former minister in the Koizumi cabinet and author of its many recent reforms came up with a new acronym describing many Asian countries as CRIC economies — Crisis, Reforms, Improvement, Complacency. Given the deterioration in some of the exogenous circumstances relating to India — a global slowdown, relentless rise in price of petroleum and food products, and tardy response to many weaknesses, India may have entered the ‘complacency phase’.

Mumbai may have decoupled with the happenings in Delhi. However, ignoring emerging trends will prove costly.