Economic Survey accepts the hard realities—finally

Reviving growth will require tough measures in the coming year

Updated: Wed, Feb 27 2013. 07 31 PM IST

The latest Economic Survey written by economists in the finance ministry begins on the mandatory note of optimism. It predicts a mild growth recovery in the next fiscal, which is reassuring but for the fact that its 2012 edition had said something similar on the very first page: “There are signs from some high frequency indicators that the weakness in economic activity has bottomed out and a gradual upswing is imminent.” According to the latest government estimates, India will be ending this fiscal with its slowest pace of economic expansion in a decade.

What is more interesting is the analysis by the finance ministry of why the Indian economy has landed in its current mess. Here is a simplified (and politically incorrect version) of this analysis. After the global financial crisis, the government gave a boost to consumption even as the investment climate was allowed to deteriorate. Supply could not keep up with demand. Inflation flared up. Monetary policy had to be tightened, which hurt growth even more. Meanwhile, the national savings rate fell because of two factors: a rise in government deficits and high inflation. The decline in savings led to a record dependence on foreign savings, aka the current account deficit, which is now the single biggest threat to economic stability.

There is little to disagree with this analysis. It merely reflects the growing recognition that the Indian economy is in the midst of a structural rather than cyclical slowdown. Official agencies such as the Reserve Bank of India and the International Monetary Fund have already said that India’s potential growth rate has fallen since 2008. Private sector economists worry that a further decline in the savings rate as well as an increase in the incremental capital-output ratio, a measure of efficiency, will pull medium-term growth to well below 6%.

The big question right now is: What is to be done? Two implicit themes emerge in the new Economic Survey. One could call them tax pessimism and export pessimism.

Consider tax pessimism first. The finance ministry quite correctly says that the government needs to collect more taxes, preferably by widening the tax base rather than increasing tax rates. The importance of the proposed goods and services tax is obvious. But the immediate strategy of fiscal correction is clearly based on hopes of spending discipline, “especially by shrinking wasteful and distortionary subsidies”. There is a good reason why tax collections will not be buoyant: Nominal gross domestic product growth in 2012-13 was the lowest in a decade, and could deteriorate further in case growth does not pick up while inflation moderates.

And now look at export pessimism. “India cannot take the external environment for granted,” the survey points out. The global economy has perhaps put the worst behind it, but it is definitely not out of the woods. In particular, Europe continues to struggle while the situation in China needs to be watched carefully. Any realistic strategy to reduce the trade gap has to focus on lowering imports rather than hoping for a strong export revival. Gold imports are the main problem here.

Putting all this together gives us a view that is slightly more sobering. Central to India’s current economic problems is the fiscal deficit. It has been inflationary, has pulled down the national savings rate, and eventually made India heavily dependent on foreign capital. Most economists would agree that India needs to substantially bring down its fiscal deficit over the next few years.

What is less appreciated that the process may not be smooth. Austerity will harm growth immediately while creating the conditions for lower inflation and higher growth in the medium term. Here is what the Economic Survey says in a moment of candour: “India is caught in a vicious circle of falling growth and stimulus withdrawal that could well exacerbate the decline.”

What this means is that the road out of the current mess could be far rockier that many people in government and outside seem to believe. It will inevitably involve a combination of demand compression and supply-side reforms, both of which could involve pain. But it is unrealistic to believe that the bill for more than five years of economic mismanagement can be paid off in a jiffy.

This is the backdrop for the national budget that finance minister P. Chidambaram will unveil on Thursday. He will have to chart out a course to reduce the fiscal deficit, compress demand, encourage financial savings, improve the business climate and attack the structural impediments to faster growth—a tall task in the looming shadow of a general election.

ROHIT SINGH

PGDM 2nd SEM