November 17, 2011
Planning for Bad Times
By Nitin Desai
The prospects for the world economy look bleaker by the day. The Eurozone is on life support and the slow down of growth in Europe may be even more drastic than what current projections suggest. The US is heading towards a difficult election year which will mean the postponement of much needed budgetary corrections. Japan’s economy remains trapped in a catatonic coma and even China is showing signs of a slow down. The Indian economy too is slowing down to a 7% or below level, though the GOI is in denial.
Given this starting point the chances are that we are in for half a decade of slow global growth. Protectionism has not yet surfaced in official policy, but may not be too far behind with the way politics is evolving in the West. Global financial flows will remain sluggish till foreign exchange and financial markets settle down as potential investors in the West sit on cash which they may need at any moment given the fragile state of financial institutions.
In the light of these prospects the Planning Commission’s Twelfth Plan goal of 9 per cent growth looks increasingly implausible. To be fair, the approach paper does recognise the “sudden increase in uncertainty about the global economy”. But the numbers it projects do not seem to factor in any significant slow down in export growth or foreign capital inflow. It projects a current account deficit for 9 per cent growth at 2.5 per cent of GDP which is more or less the same as in the eleventh plan. By implication this suggests that they expect exports to continue to grow at the same high rate as in the recent past. The capital account balance is projected at 5 per cent of GDP which is higher than the eleventh plan level of 3.8% of GDP. In fact the approach paper states : “It should not be difficult to secure the capital inflows necessary to finance a level of CAD of 2.5 percent of GDP, relying on stable long term Foreign Direct Investment (FDI) flows.”
These numbers may look plausible if one looks at the past. But the fact is the global economy may be going into a long period of disruption and restructuring which will upset these trends. Forecasts for the next few years range from the calamitous to the merely pessimistic. Prudence requires that we should work out our sums on the basis of assumptions about exports and foreign capital inflows that scale down the trend forecasts quite significantly. Please also note that getting foreign capital inflows on the scale envisaged in the Approach Paper will require a more hospitable view of Chinese investments than at present.
This message of caution is reinforced when one looks at what is happening to the drivers for growth that the approach paper identifies. The first driver identified is the high rates of investment and private savings. The approach requires a further increase in these by about 5 per cent of GDP. The fact is that these ratios are already on a downswing. The boost that came from the big rise in corporate savings is threatened by the squeeze on profit margins caused by the RBI’s anti-inflationary interest rate hikes and rupee depreciation. Many investment plans have been put into cold storage.
The approach paper talks of the increased openness of the economy, the dynamic outward oriented private sector and the flexibility provided to entrepreneurs with delicensing as the other driving force that has unleashed productivity enhancing competitive pressures. There are proposals for a further opening of the economy that may or my not materialise given the current state of party politics and the paralysis of decision making in Delhi? In any case the external liberalisation that is pending relates mainly to investment rather than trade and the impact of that on the dynamism of the domestic corporate sector will not necessarily be positive.
The broader secular factors underlying high growth like the improvements in management and labour skills and the aspiration for change particularly among the young that the Approach Paper mentions remain valid but will not compensate for a greatly worsened global environment.
The Approach Paper does recognise that the Twelfth Plan will be subject to “considerable short term uncertainties in the global economy”. But its argument for revisiting the growth targets at the time of the mid-term appraisal seems to be more for raising the target “if the global environment improves, and policy reforms, which could raise the growth potential of our economy, become a reality by that time.”
Bad times require good and realistic planning and that today means a willingness to face the challenge of global economic turmoil rather than wishing it away.
The Twelfth Plan must be based on a more realistic appreciation of the long period of turmoil in the global economy that is before us. Planning and investing for 9 per cent growth and hitting 7 per cent could lead to serious problems of overcapacity, lowered profitability and non performing assets in the books of lenders. On the other hand planning for 7 per cent may not necessarily stand in the way of hitting 9 per cent, if that becomes possible, provided there is some slack in non tradeable infrastructure capacity. Yet another downside of failed optimism about growth rates could be large errors in fiscal projections with the Government committing resources which do not materialize because of slower growth. Perhaps it is too late to formally revise the growth targets. Then the revised Approach Paper must at least work out an alternative with a lower growth rate to identify the problems that could arise.
The other reorientation that is needed to cope with the worsening global environment is to focus policy reform strongly on boosting the growth in domestic demand and not count on a FDI led export-led growth acceleration. These policy measures to boost domestic demand growth could include programmes to raise productivity and incomes in rural India, logistical and other measures to bring Northern and Eastern India more firmly into the high growth economy, accelerating the urgently needed investments in affordable housing and urban infrastructure, improving the competitive capacity of domestic equipment producers to list just some of the available options. All this may be necessary even to protect the prospects for 7 per cent growth.