Shankar Acharya: Crises still building
by Shankar Acharya / Aug 27, 2012, 00:23 IST
source: Business Standard
At the beginning of this year, I had pointed out that because of the United Progressive Alliance government’s prolonged lack of progress on economic reforms, its continued fiscal profligacy, a series of damaging decisions injurious to the investment climate and a weak and uncertain global economic environment, a number of crises were building (“Roosting chickens, building crises”, Business Standard, January 12, 2012). Four were specifically outlined: “an old-fashioned external liquidity crisis”; “a painful and drawn-out crisis of several years of sub-seven per cent economic growth”; a lack of jobs for unskilled and semi-skilled labour, which might convert “the ongoing ... youth bulge into a nightmare of unemployment, under-employment and social unrest”; and, consequent “on such squandering of our development potential”, the weakening of “our national security in the medium and long run”. Now, more than seven months later, it may be instructive to assess what progress, if any, the Gandhi-Singh government has made in warding off these premonitions of crises.
We have already had a foretaste of external liquidity pressures in two bouts of sharp exchange rate depreciation, the most recent of which was in the weeks after the retrograde March Budget, which took the rupee/dollar parity to around 56, where it has hovered since, compared to the rate of 44-45 a year ago. This sharp nominal depreciation of about 25 per cent is both a reflection of external liquidity pressures and a means of encouraging improvement in our current and capital accounts. Cheaper rupee assets, some progress in resolving the euro zone crisis and renewed hopes of fiscal corrections and reform actions by the Indian government appear to have helped attract strong inflows of foreign portfolio investment, which have eased the financing of the large current account deficit and supported the rupee at present levels.
But after two changes in finance ministers and a diet of brave words but little by way of long-promised, bullet-biting actions, especially on the crucial issue of diesel price increases, hopes may again be fading. External credit rating agencies have placed India on a negative outlook for a downgrade from investment grade, and external debt markets for Indian paper are already pricing them near junk status. With its economy contracting, the euro zone continues to be fraught with high risk, and the possibility of a highly destabilising Israeli attack on Iran remains substantial. Recent data show a decline in Indian exports in the first quarter of 2012-13 and a further deterioration of our external debt profile. The Prime Minister’s Economic Advisory Council (PMEAC) projects a current account deficit of almost four per cent of GDP in 2012-13 in its latest Economic Outlook. In short, our external finances remain very vulnerable to shocks and swings in sentiment. The longer we postpone overdue petroleum product price increases and growth-enhancing policy actions, the higher the chance of renewed external pressure and another disruptive tumble in the rupee’s value.
And this time it may prove harder to manage and contain the collateral economic damage of a sudden depreciation, since the domestic financial system is now clearly stressed by rising levels of non-performing and restructured loans to a growing number of sizable companies, especially in the power, telecom, real estate and mining sectors.
As for the medium-term crisis of low (sub-seven per cent) growth, we are now well into the second year. The rapid deceleration during 2011-12 saw the quarterly growth rate plummet from above nine per cent in the last quarter of 2010-11 to 5.3 per cent in the final quarter of 2011-12, yielding an average growth for the full year, 2011-12, of 6.5 per cent, the lowest in nine years. With the index of industrial production showing no growth in the first quarter of 2012-13 (down by 0.7 per cent for manufacturing) and the weak monsoon suggesting little growth in agriculture (the otherwise optimistic PMEAC Outlook projects 0.5 per cent for 2012-13), most independent analysts and forecasters foresee GDP growth to be below six per cent in 2012-13. It is hard to reconcile the currently known facts and data about the economy with the prime minister’s Independence Day speech expectation of “a little more” than 6.5 per cent. The more recently published PMEAC Outlook projects 6.7 per cent, but its associated forecasts of 5.3 per cent for industry and 8.9 per cent for services seem very optimistic.
Some people have trouble reconciling India’s 35.5 per cent ratio of aggregate investment to GDP in 2011-12 with her current low rates of growth. Earlier this month, the prime minister also was reported to have drawn comfort from India being “a high savings, high investment economy”. But consider the following points. First, the aggregate savings rate has declined from a peak of 37 per cent of GDP in 2007-08 to 31 per cent in 2011-12, thanks mainly to high central government revenue deficits and lower corporate profits. Second, the aggregate investment rate includes the recent increases in stocks of privately held gold and publicly held foodgrain, neither of which contributes noticeably to output. If one focuses on ratio of gross fixed investment to GDP, that ratio has fallen from its peak of 33 per cent in 2007-08 to about 28 per cent in the second half of 2011-12. Third, the aggregate investment data include spending on projects, quite a few of which have been stalled since 2010 because of tighter environmental constraints, scams, court judgments and other impediments. They also include the costly investment in around 25,000-30,000 MW of mostly new power generation capacity, now standing idle because of absent linkages to coal or gas, or because near-bankrupt state distributing companies lack the money to purchase their power.
Until these critical infrastructure bottlenecks are sorted out, and there is a marked improvement in fiscal imbalances, the investment climate and financial sector health, it is hard to see how India’s growth can break out of its current five to seven per cent band. The economic and social welfare losses of such avoidably low growth are massive.
The third crisis of growing scarcity of jobs for the “youth bulge”, the vast majority of whom lack usable skills, has been building over decades and has clearly got worse with the slowdown in economic growth, especially in labour-intensive manufacturing. The recent increase in industrial disputes, sectarian strife and other social stresses has multiple causes, including the worsening shortage of decent employment opportunities.
Finally, it was heartening to hear the prime minister, in his Independence Day address, draw attention to the strong link between our sustained economic progress and our national security. That security has clearly been weakened by our faltering economic performance. Equally clearly, it can only be restored and enhanced when our government and politics work to implement sensible, growth-promoting economic policies.
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The author is Honorary Professor at Icrier and former Chief Economic Adviser to the Government of India.
Views expressed are personal
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