Nearly eight years have passed since the first United Progressive Alliance (UPA) government led by Sonia Gandhi and Manmohan Singh came to power. That’s a long time in politics, long enough for many of the politically expedient sins of commission and omission to yield their unfortunate consequences. In the economic domain the chickens have begun to come home to roost over the past year.
Consider the following potent brew of policy actions and non-actions:
- No significant economic reforms were carried out since 2004, with the honourable exception of the successful fiscal consolidation, which brought the combined (Centre and states) deficit down from above eight per cent of GDP in 2003-04 to four per cent in 2007-08 and helped fuel the savings and investment boom of that period. The lack of reforms has now slowed growth of productivity and output.
- That solitary major success was squandered in 2008 with massive subsidies for oil, fertilisers and food, the Sixth Pay Commission decisions, the farm loan waiver scheme and ramping up of the national rural employment guarantee programme. The combined deficit more than doubled, to 8.5 per cent of GDP, with the initial burst of populism cloaked by the later jargon of “fiscal stimuli” to counter the global crisis of 2008-09. The deficit rose further, to nearly 10 per cent of GDP in 2009-10, and has remained above eight per cent, fuelling inflation and keeping longer-term interest rates high.
- This fiscal laxity has also placed the full burden of inflation-fighting in the last two years on monetary tightening by the Reserve Bank, with consequent disproportionate damage to investment.
- The UPA’s continued predilection for expanding entitlement programmes, such as the Right to Education Act and the Food Security Bill, does not augur well for fiscal correction in the near future. Incidentally, the former threatens closure of thousands of private primary schools, while the latter has been widely criticised for massive design flaws which may render it counterproductive.
- The other key, time-tested and successful macroeconomic policy of “managing” the exchange rate of the rupee was abandoned after 2007, especially since 2009. The predictable (and predicted) result of unchecked rupee appreciation in the past two years has been soaring trade and current account deficits since 2010, an increase in external sector vulnerability, the costly shock of the steep depreciation of recent months, and a significant drag on industrial growth (as I predicted in my 2010 columns of April 10 and 22, September 23, October 28 and again on November 25).
- Since early 2008, world energy prices have increased sharply, with crude oil typically at or above $100 per barrel. The government has tried to suppress this hard fact by maintaining control over consumer prices of diesel, kerosene and LPG. Even the decontrol of petrol prices is not complete. The results have been huge subsidies (estimated at over Rs 1 lakh crore in 2011-12) mostly to the better off; rampant adulteration of diesel and petrol; a setback to energy conservation; and the discouragement of domestic oil and gas production and of alternative energy sources.
- The sluggish reforms in the coal sector, combined with the sudden promulgation of “no go” areas in 2010, have shackled utilisation of India’s most abundant energy resource, led to further strains on the rickety electric power sector and required much higher coal imports.
- The tightening of environment regulations in 2010 also hit high-profile investment projects more generally, including major mining projects in Orissa, the Lavasa township project in Maharashtra and the Mundra port in Gujarat. This has clearly affected “animal spirits” and investment adversely.
- Either because of “coalition compulsions” or simply weak governance, massive irregularities and scams have been spawned in a number of sectors where the nexus of governmental discretionary decision-making and crony capitalism is high, including telecom licence and spectrum allocation, mining, Commonwealth Games projects, various land allocations and large government expenditure contracts. Subsequent discovery and scandal have been followed by widespread investigations, indictments and political mud-slinging, which, in turn, have contributed to a near stasis in normal administration and decision-making. This has further eroded entrepreneurial “animal spirits” and investment intentions.
- All this has taken its toll of India’s resilient bounce-back from the global crisis of 2008 and 2009. Economic growth has slumped from an annual rate of 8.9 per cent in 2010-11’s second quarter to 6.9 per cent in the second quarter of 2011-12. With industrial production in October 2011 showing a contraction of five per cent, overall economic growth is expected to decelerate further in the second half of 2011-12. Worse, all indicators of investment (such as construction activity and capital goods production) are significantly negative. Economic growth in 2012-13 could easily be below seven per cent — perhaps significantly so, if Europe gets into a full-blown crisis.
With economic growth slowing below seven per cent, the combined fiscal deficit still at an unsustainably high eight per cent-plus of GDP, headline inflation close to nine per cent, the foreign trade (goods) deficit over 10 per cent of GDP, the current account deficit approaching four per cent of GDP, external commercial debt at a record high, capital inflows skittish and the global economic situation weak and uncertain (Europe on the brink? Oil prices?), the macroeconomic signals are flashing red. Among the crises that are building are:
- An old-fashioned external liquidity crisis, perhaps precipitated by a European “blow-out”, or a surge in politically sensitive international oil prices. Given the overhang of maturing external debt and rising foreign scepticism about India’s economic management capacities, our forex reserves of $300 billion may not suffice to tide us over an external shock, if fiscal policy continues to be profligate and reforms remain stalled. If we do get into such a crisis, it is going to be a lot harder to dig ourselves out than in the early 1990s.
- In the medium term, even if we can avoid an external payments crisis, lower investment levels and the sharpening constraints in energy, water and urban infrastructure could spawn a painful and drawn-out “crisis” of several years of sub-seven per cent economic growth, well below the 12th Plan’s aspirations of nine per cent, which could catalyse a number of economic, social and political vicious cycles.
- In the longer run, the continued absence of meaningful policies to substantially increase job opportunities (real jobs, not the make-work kind) for unskilled and semi-skilled labour in employment-intensive sectors is increasingly likely to convert the ongoing “demographic dividend” of the youth bulge into a nightmare of unemployment, under-employment and social unrest.
- Such squandering of our development potential could profoundly weaken our national security in both the medium and the long run. We live in a dangerous neighbourhood fraught with real threats and serious uncertainties and cannot afford such self-inflicted weakness.
Happy New Year!
The author is Honorary Professor at Icrier and former Chief Economic Adviser to the Government of India.
These views are personal