All Is Not Well with Indian Economy — Current Account Deficit Headed for a Record High

Speaking at the 10^th annual convocation of the Indira Gandhi Institute of Development Research, Subbarao, Governor, Reserve Bank of India (RBI), said that the nation is today facing three concerns relating to the widening current account deficit: first is the level of the CAD—in the second quarter of current fiscal it stood at 5.4 per cent and is all set to become the historically highest as percentage of GDP; the second is its quality—this high deficit is due to import of oil, which is price-inelastic and gold, a non-productive asset; and the third is the way the CAD is financed—being financed by increasingly volatile flows.     

That aside, growth in GDP in the current fiscal itself is estimated to be about five per cent as against the 6.2 per cent recorded in the last fiscal, which is going to be the lowest in the last decade. And the worst of it is: it is accompanied by a fall in domestic consumption, net fall in exports, and a fall in investments. The cumulative effect of these three would be more disturbing, for it would hurt the growth potential in the coming years too.

There is, of course, a faint hope that this figure may be revised upwards, at the end of current quarter of the fiscal, for after all, this figure is arrived at from the extrapolation of first three quarters’ figures. Nevertheless, it makes sense only if there are real signs of recovery in the economy—the profit figures of corporate is certainly a pointer towards that direction. Here again, there is a strong argument that whatever solid performance that the corporates posted under profit is more out of their effective cost-cutting exercise rather than growth in sales. If this argument is taken to its logical end, it becomes evident that there is not much hope for new investments. With no encouraging performance under exports or for that matter under infrastructure investment in the country, there is not much hope that the CSO’s current estimate of GDP is likely to be revised upwards.  

This is further vindicated by the data released yesterday that shown a shrinkage of country’s industrial production by 0.6 per cent in December, 2012. This is indeed the sixth  monthly decline in the last nine months of the  current fiscal, which is mainly attributed to the drag down in the industrial out put — Index of Industrial Production declined by a sharper 0.84 per cent in November than the estimated 0.1 per cent—and the problems in the mining sector. Which is why, even to achieve five percent growth in the GDP, the industrial production should leapfrog in the fourth quarter, argue analysts.

We must also take note of another peculiar feature of our economy: growth rate is falling but inflation is persistently staying high—the latest consumer Price Index-based inflation rate rose to a record 10.79 per cent in January from 10.56 per cent in January. This imbalance between decelerating growth and high inflation, that too much against the experiences of fellow emerging economies, is a matter of great concern. There are reasons galore for this disturbing feature of our economy: no policy direction that could encourage investments in industrial sector. For the last eight years, the present government has indeed suffered from reform-paralysis, and as a result, the investors have found no incentive to invest in the country. It is sheer mismanagement of the economy that left the country at such a pass.

In order to give a boost to the growth in economy, the RBI has, in its latest credit review, brought down its policy interest rate by 25 basis points to 7.75 per cent from the earlier eight per cent. Though it is in the right direction, by itself it would not be able to nudge growth forward. Secondly, with the food prices still rising— the consumer Price Index-based inflation stood at a record high of  10.79 in January—the RBI might find it difficult to further ease the interest rates.

Nor would expansionary fiscal policy be able to push it forward. True, before an election year, governments are often tempted to dole out populist subsidies, but such a move is fraught with the risk of stoking the inflation further. And higher inflation will only drive away the voters from the party in power.

So, what the government should do is, to continue with its good work of reducing subsidies on diesel and cooking gas and deploy the released capital for giving a boost to infrastructure development, for it not only generates employment right now, but also paves the way for growth in industrial output. Simultaneously, the government should also explore taxing the affluent differently, for such additional funds can be utilized for re-skilling the youth for industrial employment.

At the same time, the government should show courage to launch necessary structural reforms, for that alone would make private money move into the country. This is a must to put India back on growth track—the faster, the better. The all-time high of Sensex despite the high inflation, poor growth forecast, falling investment rate, worsening CAD, and heavy public borrowing are only pointing that India is about to turn a corner.  Taking advantage of the global investors’ mood, the finance minister must come out with a budget that reins in fiscal deficit and an expenditure statement that enhances productivity and employment in general, along with necessary reforms that make capital investment in India attractive. This is the right time to garner international capital, for it is looking for attractive investment centers, as Europe and the US continue to suffer from poor market demand.

Had the Manmohan Singh government launched reforms under the aviation, retail and insurance sectors along with deregulation of oil prices, the growth story would not have been this bad. Let bygones be bygones. At least, we must act now: to use or lose this capital that is circling the globe in search of attractive investment avenues. For, that alone can put us back on growth track.

Now, will the Finance Ministry come out with a pro-investment Budget for achieving turn around in the economy, is what we all have to wait and see.