As autumn shades into winter, the clouds over India’s economic performance and prospects are getting bigger and darker. First, the international economic climate is getting gloomier by the week, with a rising threat of a major “event shock” from Europe. Second, India’s economic growth has slowed and there is growing evidence that the deceleration will continue. Third, aggregate investment has slackened and it could get worse. Fourth, inflation continues to be stubbornly high, fuelled in part by a worsening fiscal deficit. Fifth, the country’s external imbalances are growing at a time when capital flows are becoming more volatile. Sixth, and perhaps most worrying, there is little evidence that the government appreciates the gravity of the problems and even less that it has the capacity and the will to coordinate and implement an effective programme to mitigate the rising threats to economic performance. Each of these merits some elaboration.
Over the past few months international economic news has been dominated by the extraordinary spectacle of European policy-making, if that’s the right word to describe the seemingly never-ending circus of European summits, flawed bailout agreements and subsequent back-sliding to cope with the witch’s brew of sovereign fiscal stress, banking fragility and stalled growth. More than 18 months after the Greek fiscal crisis reared its ugly head, Europe has yet to find a lasting solution. What was manageable in the initial stages has spun increasingly out of control as European political will has lagged consistently and tragically behind economic necessity. Greece is stumbling in search of effective leadership, as is her far more important neighbour, Italy; bond markets are close to panicking; much of Europe has stopped growing – or is already in recession – and the durability of the euro zone is in serious doubt.
Unsurprisingly, successive editions of global economic projections, by the International Monetary Fund, the Organisation for Economic Cooperation and Development and the European Union, foresee increasingly slower growth in the major economies of Europe, US and Japan for the next couple of years and an even worse outcome if there is an event shock, such as a default on a European government’s debt or a major bank failure. Some look hopefully to the BRICs – Brazil, Russia, India and China – for economic salvation of the world economy. But with nearly 60 per cent of the world economy (US, EU and Japan) hardly growing, it is surely unrealistic to expect the BRICs (with about 20 per cent of global output) to provide the missing “locomotive” role. Indeed, the opposite is more likely and is happening: the economic problems in the industrial world are pulling down the growth of exports, investment and output in the major emerging nations, including China and India. In short, near stagnation in the industrial world will continue to constrain India’s growth potential for several years.
India’s growth has been slowing over the past six quarters for this and several domestic reasons including: tightening supply constraints (because of a prolonged lack of effective reforms), rising interest rates, ham-handed implementation of environmental regulations and the succession of scams and scandals (notably in the allocation of telecom spectrum, land, mining rights and some large government contracts), which have fuelled political acrimony and ground governmental decision-making to a virtual standstill. The latest data show that industrial growth slumped below two percent year-over-year in September, the lowest in many months. More ominously, some key service sector growth indicators have fallen sharply in April-July 2011 compared to April-July 2010: for example, cell phone connections to minus 31 per cent from plus 37 per cent; domestic air cargo traffic to minus 5.3 per cent from 33.6 per cent; and international air cargo traffic to 3.9 per cent from 25.3 per cent. HSBC’s Purchasing Managers’ Index for services fell to 49 per cent in October from above 60 per cent eight months ago. Given that services (including construction) account for about 65 per cent of India’s GDP, these trends are very worrisome.
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Of perhaps greater concern is the growing evidence indicating a slowdown in investment. Growth of the key construction sector had slumped to 1.2 per cent in April-June, 2011. Capital goods growth plummeted to minus 6.8 per cent in September. Project finance data from financial institutions show a halving of the rate of commitments in the first few months of 2011-12 compared to the previous year. Numerous major projects are stalled or delayed due to regulatory setbacks and uncertainty relating to land acquisition, environmental rulings, cancelled coal linkages and so forth. Rising interest rates and falling corporate profits have tightened financial constraints on investment. Uncertainty over global economic conditions and a near paralysis in domestic governance cast a heavy pall over investment plans.
The outlook for production and investment is darkened by growing macro imbalances. The foreign trade deficit widened sharply in October to an unsustainable $20 billion, with the ratio of merchandise exports to imports dropping to barely 50 per cent for the first time since the 1980s. As the negative fallout from Europe grows and oil prices stay high (as most expect), external imbalances could easily worsen. Inflation remains stubbornly high, constraining the scope for investment-friendly monetary easing. The fiscal deficit is running well above budgeted levels, fuelling inflation and pushing benchmark 10-year government bonds close to nine per cent. The banking sector is beginning to feel the stresses of a faltering economy. Debt restructuring exercises and non-performing loans are on the rise. The situation will worsen as the credit cycle turns south. It’s not a pretty picture.
The biggest and darkest cloud is the government’s apparent failure to appreciate the gravity of the economic situation and do something effective about it. Reforms, which should have been undertaken long ago, could be initiated now. Untimely populist programmes could be shelved, or at least postponed. Day-to-day administrative decision-making could be greatly improved. None of this is happening. And if the newspapers are to be believed, stasis is likely to continue from a weakened and fractured coalition government. But then let us be clear about the economic costs, which are already palpable. They will cumulate in the months ahead and further undermine investment, growth and macro stability. We could be in for several years of below-seven per cent growth; and worse if the Europe suffers a full-blown crisis.
The author is Honorary Professor at Icrier and former Chief Economic Adviser to the Government of India. Views expressed are personal