Indian economy's new normal

Most forecasters are revising their growth projection for the current financial year. The Reserve Bank of India in its latest monthly bulletin noted that the Indian economy can break out of contraction in the current quarter — one quarter sooner than its earlier forecast. The official data for the July-September quarter (Q2) will be released this week, which will give a clearer sense of the state of the economy. Corporate sector performance during the quarter surprised on the upside, and it is possible that gross domestic product (GDP) data would also be on similar lines.

However, a slower pace of contraction in Q2, or a possible break out in the current quarter, would not end the problems of the Indian economy. According to estimates, the size of the Indian economy at the end of financial year 2021-22 (FY22) is likely to be smaller than in FY20. In this context, it’s worth recalling that even before the pandemic started affecting economic activity, growth was slowing, which had generated a lively debate about the nature of the slowdown. Some of the factors affecting the economy, such as financial sector weakness and the state of government finances, would become more challenging.

One of the other big reasons cited for slowing economic growth in the pre-pandemic period was increasing protectionism. India’s intention to continue on this path was made clear by its reaction to the recent signing of the Regional Comprehensive Economic Partnership (RCEP) agreement, which will create the world’s largest free trade area. The 15 participating countries generated over 30 per cent of global output in 2019 and, according to HSBC’s estimates, this will increase to over 50 per cent by 2030.

While the members have left the door open, India doesn’t seem inclined to join RCEP even at a later date. The official position is that joining RCEP would have had negative consequences for the Indian economy. India withdrew from negotiations last year. There is also a belief that past free trade agreements (FTAs) have hurt India’s interest. However, it’s worth debating whether India is taking a bigger risk by staying out of the world’s largest and, perhaps, most dynamic trading area. It is important to recognise that India’s FTA partners have not dumped their products in the Indian markets and the overall deficit on the current account has been fairly stable over the years.

India’s current account deficit did expand sharply in the aftermath of the global financial crisis, which resulted in a near currency crisis in 2013. But, that was purely a result of poor economic management. As former CII president Naushad Forbes has shown in this newspaper, India’s FTAs have not had an adverse impact (India’s FTAs: Threat or opportunity? September 19, 2019). Also, India has had a large trade deficit with China without having an FTA. The fear is that India will be flooded with Chinese imports if it joins the RCEP. However, tariffs are expected to go down over the years, which will give time to prepare. It will also allow India to increase exports.

To be sure, India won’t be able to become an important part of the global value chain (GVC), which is critical for exports, by shutting itself to the most dynamic region in the world. This will also affect investments, as multinational corporations would want to invest in countries that are more competitive. GVC requires seamless movement of goods, which will not be possible with high tariff barriers. Granted, some investment would still come in to produce for the local market and, possibly, even for exports. But that is unlikely to be a match for India’s potential. There is ample literature to show that international trade makes the economy competitive and it is difficult to grow at a higher rate sustainably without higher exports.

Therefore, India will have to focus on trade and exports to attain faster economic growth, and this is not something that India has not done before. As economists Arvind Subramanian and Shoumitro Chatterjee noted in a recent paper (India’s Export-Led Growth: Exemplar and Exception), India recorded the third-best exports growth performance among the world’s 50 top exporters between 1995 and 2018. However, the paper also noted that India is an outlier in terms of low-skill exports. Given its labour force, India’s low-skill exports are lower by $60 billion annually than what they should be. It also showed that India is missing production worth $140 billion or about 5 per cent of GDP in the low-skill textile and clothing sector. If India focuses on such areas, it will help boost both output and exports. India anyway does well in terms of high-skill exports and should be able to compete going forward.

However, with the evolving policy framework, trade is unlikely to boost economic activity. Most commentators have advised the government against withdrawing from RCEP and increasing import barriers. India has tried import substitution before. It did not make businesses more competitive, and the outcome is unlikely to be very different this time around. Thus, the government would do well to holistically review its recent decisions on the trade front. Some forecasters are now projecting India’s medium-term growth at sub-five per cent. In the absence of corrective policy decisions on the trade front, and with the given macroeconomic challenges, such forecasts might start sounding more realistic.