March 20, 2013
Is the Worst Over?
By Nitin Desai
Is the worst over? The Finance Minister and his Chief Economic Adviser believe that the economy has bottomed out, that growth is now on an upswing and that inflation is coming under control. The Prime Minister assures us that in two to three years we will be back on a high growth path. How plausible are these statements?
The plausibility of the prognosis about growth and inflation in 2013-14 depends on three things – whether the budget numbers will pan out as projected, whether the current account deficit will continue to be financed by FDI and FII inflows and whether business sentiment has recovered enough to revive investment.
Some of the signals like the slow revival of IIP growth in recent months and credit growth are mildly positive. The corporate sector seems to have reacted favourably to the budget. The share market remains a tug-of-war between the bulls and the bears with no decisive move one way or the other as there is nothing in the earnings figures or investment intentions to justify any up or down trend. This matters greatly because a buoyant share market is necessary to realise the budget goals of public sector disinvestment and the balance of payment strategy of attracting foreign inflows.
That brings us to the budget numbers. The projected deficit for 2012-13 is lower than what was anticipated a few months ago; but that is largely on account of a drastic cut in plan expenditure in this fiscal year. The projected deficit of 4.8% is as proposed by the Kelkar Committee; but it rests on a 19% growth in revenues, which is more than what can be justified by the projected 12-13% increase in nominal GDP. The expenditure projections for the plan look high only in comparison with the revised estimates and not against what was budgeted last year. This matters because a large reduction in plan expenditure may become necessary half way into the year if the revenue and deficit numbers look like going off course. This will be much more difficult as departments have been held down to only a modest increase. Moreover the electoral compulsions will also pose a political constraint on major cuts in the big social welfare schemes. Other budget numbers, like the spectrum auction proceeds and subsidy estimates could also be questioned.
The other big problem is the current account deficit which is the difference between gross national expenditure and gross national income, in effect our national dissaving that is financed through borrowings or drawing down reserves. Containing the current account deficit means reducing dissaving within the country and the main culprit here is the dissavings of the government as reflected in the revenue deficit. This has not come down much in the budget and hence there is no real prospect of getting to grips with the 5% plus current account deficit and bringing it down to the 2.5% which is considered manageable. At a more instrumental level there is no sign of any special effort at raising exports or containing imports, except for gold imports where some steps have been taken but more needs to be done. Turmoil in the oil market or a ratings downgrade and flight of foreign capital would push us beyond the brink and require measures so drastic that not just short term but even medium term growth will suffer.
The assurances about the prospects for high growth in the medium term rest on two factors. The first is the rate of investment that, even now, is over 32% of GDP. Even with a capital output ratio of four this translates into 8%. However one must recognise one big difference between the 2004-09 period of high growth and the nature of growth in the years ahead. The past period of high growth involved a huge expansion of services that are not as capital intensive as manufacturing. The next phase will have to depend more on manufacturing and related infrastructure and those have much higher capital output ratios. Hence some downward adjustment in the growth potential associated with any given level of investment is necessary.
The other factor that leads to a belief that we are somehow predestined for high growth is the so called demographic dividend, the growth in the proportion of working age persons in the population. But realising this dividend involves major shifts in the growth process. First the locus of growth has to shift from the South and the West to the North where the bulk of the increase in the working age population will take place. Second, high growth will have to generate more jobs proportionately than it has done in the past. Third, the new workers will have to be imparted the skills needed for these jobs. Fourth, employment intensive growth may require a much greater emphasis on small and medium enterprises, which have not done too well lately. Fifth, sustaining employment oriented growth in a non-inflationary manner requires adequate food availability and that underlines the importance of boosting agricultural growth. Sixth, this sort of growth also means more rapid urbanisation and that will generate a huge demand for urban infrastructure investments. Hence the next phase of growth will be very different from the corporate focussed growth in established industrial centres that drove the 2004-09 growth process.
A lot also depends on the outcome of the next Lok Sabha election. A clear victory for either UPA or NDA will help in reviving the policy reform and growth process. But a cobbled together coalition of regional parties supported from outside by the Congress or BJP, an outcome that seems possible right now, would mean a continuing policy paralysis and hence would be quite inimical for the growth process.
What then does the evidence suggest? Borrowing the language of the India Evidence Act, one can say that a reasonable man would consider it prudent to act on the supposition that the growth revival will be more tentative, the control on inflation more tenuous and the pressures on the exchange reserves and the rupee will be more acute than what the official pronouncements suggest. Prudence also requires that we take the predictions of 8 and 9% growth in the medium term with a pinch of salt and wait the outcome of the next election and live with uncertainty about our economic future till then.