The year 2011 will probably go down in history as the year of the perfect storm for India. Whatever could go wrong, did go wrong. This was a year that India had an opportunity to stand out globally by not so much as doing too many right things but merely by avoiding wrong moves. Alas, we blew the opportunity, thanks to politicians from all walks and to some boo-boos by policy makers.
Unlike the Asian authoritarian political regimes that favoured political openness after becoming economically open, India is moving ahead with the reverse combination, and with the additional liability of weak coalition governments. To be sure, unlike Deng Xiaoping in China, Lee Kuan Yew in Singapore or Mahathir Mohamad in Malaysia, India has no effective visionary reformist-politicians who can ably negotiate political consensus on reforms. Prime Minister Manmohan Singh, who is in office but does not seem to be in power, appears to be an accidental reformer at best.
Admittedly, political openness is also in some ways India’s key strength in dealing with its vast socio-economic and political diversity and the resulting tensions. But, nevertheless, it affects the pace and nature of economic liberalisation. The evolving endogenous local political flux will also affect the popularity and acceptability of reforms. Politicians need to realise that there is nothing preordained about India’s economic rise. State-level “doers” and their reforms will become more common even as the federal government struggles to engineer a consensus on national-level reforms.
There are several well-documented shortcomings and missteps that UPA-II can legitimately be accused of. However, attempting to push a bold reform like foreign direct investment (FDI) in the retail sector is not one of them. The recent backtracking by the government on retail FDI reveals more about the Opposition than about the government, and is yet another rude reminder about the lack of strong political consensus on reforms.
India’s Opposition parties deserve an “F” grade for stalling work in Parliament. Largely devoid of sensible and practical economic solutions, most Opposition parties mistakenly conclude that the right to protest against a government policy is also a right to no work in Parliament. The approach is myopic and is a lose-lose outcome for all.
With the local myopic political brinkmanship hurting the economic outlook, the Reserve Bank of India (RBI) will continue to be the key focus for some policy-related clarity. This is unfair to the RBI, as it is not receiving the much-needed support from the government on fiscal matters. Indeed, one sad story of 2011 has been an absence of proper coordination between fiscal and monetary policies. Consequently, the RBI had to resort to more-than-necessary rate hikes to make up for the lack of fiscal correction — which would actually have been much more effective in checking aggregate demand and hence inflation.
That economic growth has been decelerating is not news, even though it has hit a nine-quarter low of 6.9 per cent in the September quarter. Headline GDP does not reveal the whole picture, as non-agriculture GDP growth at 7.3 per cent year-on-year was better than overall growth, but still showed a deceleration. Overall, 2011-12 GDP growth is likely to be around seven per cent, lower than the RBI’s revised guidance of 7.6 per cent. Next year’s outcome is likely to be six to seven per cent, and will depend partly on the government’s constructive actions.
There are two drivers of India’s growth slowdown. First, cyclical deceleration that is a direct result of tighter monetary policy and was a key policy objective; and second, policy inertia and corruption scandals that have hurt confidence and investment. Monetary policy can deal with the first but not necessarily the second. In fact, the RBI should not even attempt to compensate for the inaction by the government.
The plunge in the October industrial production is exaggerated by the timing of Diwali holidays, but still signals further deceleration in economic growth, which has been worsened by the government’s policy inaction. Data quality issues, especially around the volatile capital goods, remain a key irritant. Industrial production will recover in November but still remain subdued thereafter. Still, the deceleration in growth sets the stage for monetary easing as inflation rolls over.
November wholesale price index-based inflation will likely decline to around nine per cent from 9.7 per cent in the prior month, and fall further in the March quarter. In its mid-year review, the RBI guided for a pause at the upcoming policy meeting on December 16, and it is likely to stick to that. Slower growth will favourably affect inflation with a lag, and the RBI should not jump the gun to ease just yet. Its guidance will turn more dovish – this is an important shift – but it will still highlight the multiple risks to the inflation outlook, including global commodity prices and local suppressed inflation.
I’d be surprised if the RBI announces a cut in the cash reserve ratio (CRR) or the repo rate later this week, given that it had raised the repo rate just six weeks ago. It will probably rely on open market operations for now and most likely ease from January onwards. A CRR cut will likely precede the easing in the repo rate.
In India, CRR is generally viewed as a monetary tool simply because the RBI describes it as such in its policy statement. However, every CRR move does not necessarily carry a monetary signal. Indeed, the RBI will be better off in de-emphasising the importance of CRR as a monetary tool even if it does not intend using it often, as has correctly been the case in the current tightening cycle. Such a de-emphasis – with clarity in communication – will offer more policy flexibility in liquidity management without compromising monetary signalling.
Unlike 2008, the problems now are home-grown, and there is only so much that monetary easing will help. The global backdrop will remain uncertain in 2012, but there is a lot that the government can do, including jump-starting public investment in infrastructure and adopting a credible fiscal correction without being fanatical. All eyes are going to be on the Budget for 2012-13, an event that credit rating agencies will also be watching closely. India cannot afford to continue with the status quo or more missteps.
The writer is senior economist at CLSA, Singapore.
These views are personal
