Opinion Beyond the budget
Economic fundamentals are strong,but lets not take them for granted. Interest rates must reduced
Economic fundamentals are strong,but lets not take them for granted. Interest rates must reduced
From a macro perspective,the key variable in the budget is the fiscal deficit of 5.1 per cent. Even though this is a reduction from the actual 5.9 per cent in the last fiscal year,it is predicated on a GDP growth rate of 7.6 per cent. This brings us back to the probability of achieving this growth rate. Whenever policy makers are asked how this growth will be achieved,the standard answer is but the fundamentals of the economy are strong,therefore…
Of course they are strong,and just to be sure,let us list them out. First,the high consumption propensity of a vast growing middle class. This is true not just for those in the big cities but also those in the small towns and villages,and is due in large measure,to the demonstration effect percolating down from urban centres. For example,one would expect to see a large number of Mercedes,BMWs and Audis in the big cities but to find a large number of these in Ludhiana illustrates the point. Further,with television advertising all over the country,growing aspirations are on a fast track. Add to this the demographic shift towards a large,growing and literate young generation. The consumption drive,in consequence,is unstoppable.
The next fundamental is a high saving rate. It is an impressive 34 per cent,though lower than Chinas. I am often asked in my lectures at IIT Delhi,how high consumption can go along with high saving. Keynes,in fact,showed us that in a situation of underutilised capacity and unemployment,we can eat our cake and have it too,that is,we can spend and save at the same time.
Third,we have world-class entrepreneurs recognised globally. Many are heading large banks,investment houses and corporations in the US and Europe. Others,ranging from heads of software to manufacturing,have become icons in India. However,the important thing is that the number of new entrepreneurs is growing steadily. Many represent the mid-cap and small-cap categories on the stock exchange. Others proliferate in the small towns of India. The Automobile Component Manufacturers Association alone has 250 members who represent small and medium size industries catering to the auto sector. Likewise,for others including electronic and white goods industries,there are a host of ancillaries and service outlets. Most are labour intensive.
Fourth,a robust banking sector it has acquired wide reach covering the urban hinterland and rural areas. Its asset composition is strong with high investments in government securities,which are least risky. Its short term foreign debt composition is small and further with a low credit to deposit ratio of 30 per cent (25 per cent SLR and 5 per cent CRR),the overall profile of the banking sector is sound. Consequently,it is in a position to extend credit.
Why credit is tight brings us to the rather touchy issue of high interest rates. With persistent inflation of 9 per cent in November 2011 and 7 per cent at present,the Reserve Bank has steadily ramped up the interest rate from 5.75 per cent in July 2010 to 8.5 per cent in January 2012. This correlates strongly with the fall in the growth of industrial production from 12.6 per cent in 2010-11 to 2.2 per cent in 2011-12 and the GDP growth rate from 9.3 per cent in July to September 2010 to 6.1 per cent in January to March 2012.
The problem is that inflation appears to be more supply-driven than demand-driven. Food prices rose steadily from July 2010 to February 2011 and then fell dramatically in December 2011. This happened with a spurt in the supply of fruits and vegetables. Likewise,the prices of fuel were determined by international oil prices. They had nothing to do with interest rates.
High interest rates,on the other hand,have hurt housing and infrastructure and are a leading cause of low capacity utilisation in the manufacturing sector. What is worse,capital investment came down with industry postponing its expansion and replacement plans,from 30.3 per cent of GDP in 2011 to 28 per cent of a reduced GDP in 2012. What we have going for us despite the setback is the high propensity to consume,but even that cannot be taken for granted.
Let us therefore learn from the experience of Turkey in 2010,where despite high inflation,interest rates were reduced. With the consequent revival of industry,inflation actually came down. Interest rate reduction for us is one of the immediate steps that will signal the revival of the GDP growth. Higher inflation as a consequence is unlikely. The other policy initiatives on the UPAs agenda,like FDI in retail and higher foreign equity in the airlines and insurance,will certainly be major steps towards the prime ministers dream of achieving a 9 per cent growth rate.
The writer is an industrialist and economist
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