Indian 'reforms' fragile in
face of poor growth outlook
By Kunal Kumar Kundu
NEW DELHI - October
is proving to be very eventful month for India,
with events swaying economic sentiment from one
extreme to the other.
As the government
continued to demonstrate its new-found reformist
attitude by announcing its intention to raise the
limits for foreign direct investment (FDI) in
private insurance companies and pension funds
(following up on the blockbuster decision to
increase diesel prices and allow FDI in
multi-brand retail), three international financial
institutions came up with revised forecasts for
the Indian, with drastic downgrades in their
growth forecasts.
The International
Monetary Fund (IMF) shocked all and sundry
with one of its most
radical downgrades, predicting India's gross
domestic product (GDP) would clock a growth rate
of a mere 4.9% year-on-year during the 2012
calendar year - down by 1.3 percentage points from
its previous forecast of 6.2% yoy growth).
The Asian Development Bank (ADB) cut its
forecast for the fiscal year 2013 (April 2012-
March 2013) by 1.4 percentage points to a revised
5.6% yoy growth, down from its earlier forecast of
7%).
The World Bank was not to be left out
of the downgrade party, though it came up with a
slightly less severe forecast for the current
fiscal year - revising it's outlook by less than
one percentage point (from 6.9% yoy to 6% yoy).
It is important to note that the IMF's
calculations are different from those of other
agencies, and for that matter from how India does
its own calculations. In fact, in a reported
interaction via Facebook, an IMF staff member has
explained that if its estimate for the calendar
year is changed to the current fiscal year and if
indirect taxes are not taken into consideration
(the way India calculates its GDP [1]), then the
IMF's forecast for India's GDP growth rate would
be 5.6%, same as the ADB forecast.
All the
three reports acknowledge the government's desire
to kick-start the reform process and consider the
recent decisions as positive, yet all of them are
worried about how the political theater will play
out in India. Added to that is the deteriorating
global economic environment.
The common
thread across all the reports is that, while the
country recovered quickly, compared with its
peers, from the financial crisis-induced global
recession by 2009, India now lacks the firepower
to consolidate that recovery; that is it lacks the
fiscal and monetary space.
While global
uncertainties are playing a significant role in
impacting on the current account balance (leading
to an unsustainably high current account deficit),
rising fiscal imbalances and generally low
business confidence caused by persistent lack of
policy initiatives are exacerbating the problem.
Before the financial crisis erupted, India
ended the fiscal year 2008 with a gross fiscal
deficit of 2.5% of GDP and a capital account
deficit of 1.3% of GDP; inflation was within
central Reserve Bank of India's comfort zone of
5%. This gave India enough firepower to stimulate
the economy.
Not surprisingly, India's
economy recovered quickly. However, it ended the
last fiscal year (to March 2012) with a fiscal
deficit of 5.8% of GDP, a current account deficit
of of 4.2% of GDP, inflation at 7.7% (average for
the year being 9%) and a policy rate of 8.5%.
All three institutions mentioned above are
deeply concerned as to how India will be able
muddle through in the present situation at a time
when global growth is again faltering again
India's GDP growth is falling at alarming levels
and when the country's politicians are acting as a
major stumbling block rather than being
facilitators of growth. As it is, India's deficits
of March this year were not too different from
just over two decades earlier, in March 1991, when
the country was also courting crisis.
That
year, 1991, marked a watershed period for the
Indian economy, when the crisis then nudged
policymakers into action and economic reforms were
ushered in. Those reform proposals did face some
political hurdles, but with a new government just
come to power, and the leading coalition party -
ie the Congress - having won as many as 233 seats,
it was far easier for changes to be pushed ahead.
Back to the present and a new impending
crisis. Previously, India expected its economy to
grow at a 4% annual pace; now 5.5% y-o-y growth is
considered to be disastrously poor. The time is
therefore ripe for policy decisions and reforms
that can put the economy back on track.
Certainly, the economy is not as
vulnerable now as it was in 1991, when India
needed a bailout. However, the persistence of
fundamental problems (both domestic and external)
can lead to increase in vulnerability to the point
of bringing on a major crisis.
Another
major difference in the present environment is in
the political situation. This time, significantly,
it has changed for the worse.
The
Congress-led United Progressive Alliance
government has been losing its political hold with
every passing day. Its disastrous performance at
recent state-level elections and a plethora of
corruption skeletons tumbling out of cupboards
with alarming regularity (with even the
chairperson now needing to duck under claims of
alleged corruption involving his son-in-law), the
party is finding it difficult to manage its allies
while the opposition is baying for blood.
And, with election barely a year and a
half down the line, things are looking far more
challenging than in 1991, when the freshly baked
coalition government took charge with an aim to
bring about change.
The political
situation is now so fluid that, despite the series
of measures announced recently, nobody - the
markets or the international institutions such as
the World Bank and International Monetary Fund -
is willing to stick their neck out and say that
this new reform drive is for real and here to
stay.
The positive sentiments generated by
the policy announcements did lead to an increased
inflow of foreign exchange, leading to a
strengthening of the rupee and an improved stock
market performance. These were, however, largely
sentiment driven. Reality soon hit as the question
of enforceability crept up, and both the currency
and the stock markets started to give up gains.
Echoing such sentiments,
Standard & Poor's reiterated its warning that,
given the difficult external environment and even
more debilitating domestic political environment
(which directly impacts business mood), the threat
of a downgrade by the credit rating company has
not waned.
While one can still expect some
sensible and less politically fraught policymaking
over the next few months, 2013 is most likely to
be a year stacked high with populist measures, as
every party enters election mode.
Unless
the government can prove otherwise (to ensure a
revival of business confidence and investment),
next year threatens to be unfortunately similar to
the present.
Note: 1. GDP
at factor cost - which is the conventional way of
calculating GDP in India - excludes indirect
taxes, since these are not considered to be
payments made to a factor of production. The IMF
includes these in its GDP calculation, as the
institution calculates GDP at market price, which
does include taxes.
Kunal Kumar
Kundu, Senior Economist & GM, India, RGE.
The views expressed are those of the author.
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