No time for half measures
Fri, Jun 08, 2012
Source : Sanjay Kumar Singh

Last week when the GDP growth number for Q4FY12 came in at 5.3 per cent, it shocked everyone. After all, growth had not sunk this low even in the quarters after the financial crisis of 2008 (the lowest then was 5.6 per cent). Are we in a worse slump now? But if you believe in the law of consequences and have been following the way economic policy has been conducted in the country for the past couple of years, you would surely know that this was a mishap that had become inevitable.

Bad policy mix

The deep and prolonged slowdown that we now seem headed for (Morgan Stanley estimates that quarterly GDP growth will languish at 6-6.5 per cent from Q3FY12 till Q4FY13) is the consequence of the policy mix that India has been pursuing since the 2008 crisis.

In the wake of the crisis, the government tried to boost consumption demand by increasing its spending. This may have been the right policy to follow then, but once growth revived the fiscal tap should have been turned off. This was never done. Instead, massive spending was made permanent through such social sector programmes as MNREGA.

The government also incurs massive expenditure on fuel, food and fertiliser subsidies. Its total subsidy bill for FY12 stood at Rs 2,16,000 crore.

Together these factors have damaged the government’s finances and pushed the combined (centre+state) fiscal deficit to the 9-10 per cent level. To fund its deficit the government borrows heavily from the markets: Rs 5,60,000 crore is planned this year compared to Rs 5,10,000 crore last year. Not only does this push the cost of capital high, it also crowds out private-sector borrowing. Consequently private investment – the most productive form of investment – has taken a knocking: between FY08 and FY12 private corporate capex has fallen by 5.9 percentage points. According to Morgan Stanley’s estimate, total investment (public+private) is expected to decline from a peak of 26.2 per cent of GDP in FY08 to 18.5 per cent of GDP in FY13.

That’s the quagmire the economy is stuck in today: high fiscal deficit combined with slowing private investment.

The government’s policy of boosting consumption has fuelled demand (especially in rural areas). But since investment has been on the decline, productive capacity hasn’t expanded. Hence, supply constraints have become endemic and inflation has turned into a perennial problem.

To deal with inflation the central bank raised interest rates 13 times between March 2010 and December 2011. The lagged impact of these rate hikes is now taking a toll on growth.

Besides the high cost of capital, private investment sentiment has also been dampened by what has come to be popularly called “policy paralysis” (this terminology will be the UPA II government’s gift to the politico-economic lexicon of this country). Land acquisition for large projects remains difficult with the land acquisition bill remaining stuck in Parliament. Numerous projects (infrastructure and mining related) are unable to take off for want of environment clearance. One consequence is coal shortage that has taken a toll on the growth of such core sectors as power.

The remedy

To get the economy out of this dangerous rut of slowing growth and high inflation, the government needs to reverse its bad policy mix. It must rein in fiscal deficit and revive private-sector investment.

To rein in the fiscal deficit, the government will have to bite the subsidy bullet. It must free up prices of fuels other than petrol (diesel, LPG and kerosene). Expediting the implementation of the UID programme and using it to target subsidies better is one way it could curtail its subsidy bill.

Another worthwhile suggestion comes from Morgan Stanley. Take up 25-30 projects that are already underway, or which can get off the ground soon and don’t face land-acquisition related hurdles. Take up their execution in campaign-style manner. The PM and key ministries should monitor their progress. If industrial projects are not viable amidst the current slowdown, then take up urban infrastructure projects in key cities. Set up a $10-15 billion fund (through the issuance of sovereign dollar bonds) and leverage that money to get projects worth $40-50 billion underway. If these projects take off, they will go a long way towards reviving private investment sentiment that has taken such a knocking, and policy paralysis will become a thing of the past.

Much hope is currently pinned on the efforts of the Prime Minister’s Committee of Secretaries, headed by the Principal Secretary to the PM, Pulok Chatterjee. The committee has been charged with the responsibility of resolving bottlenecks plaguing investments.

Should RBI cut rates?

After the GDP slowdown of Q4FY12, calls for rate cuts by the central bank will become strident. But inflation remains high with WPI at 7.2 per cent and CPI at 10.4 per cent. It could edge up further if the government raises administered fuel prices. The rupee’s sharp depreciation also has the potential to cause imported inflation, though some relief can be expected from the softening of oil (Brent has fallen below the $100 per barrel mark) and commodity prices. Hence, there is limited room for rate cuts at present. In all probability, rates will be cut by at best 50 basis points more in this calendar year. And the cuts are more likely towards the end of the year (Q4), once inflation has eased.

However, core inflation (or non-food manufactured inflation, a key measure that the RBI takes into account while formulating monetary policy) has softened. If growth falls further, or the European crisis flares up, rate cuts could occur sooner.

What lies ahead?

Once the Q4FY12 GDP growth rate was announced, growth estimates for FY13 have been pared further (Morgan Stanley: 6.3 per cent; Citi: 6.4 per cent; Goldman Sachs: 6.6 per cent). A deficient monsoon (the key determinant of rural demand) and a resurgence of the European debt crisis are two storm clouds that could depress growth further. A prolonged slowdown also has the potential to send NPAs (non-performing assets) within the banking sector spiralling higher. If banks then turn more cautious about lending, that would be a setback for the revival of private investments.

Amid this all-encompassing gloom, there are a few silver linings too. Investment rose 3.6 per cent y-o-y in Q4FY12. New project announcements by the private sector were up 16 per cent quarter-on-quarter in Q4FY12. These numbers hint that the worst of the investment slump might be behind us. Cooling crude and commodity prices will also narrow the current account deficit in the coming months.

The bottomline: policy drift which has become this government’s signature style is no longer an option. Having been rendered comatose for much of its second tenure by the 2G scam and Anna Hazare’s anti-corruption movement, the government must summon all its energies to pull the economy out of its current morass. Faith in the Sonia-Manmohan duo, which was so high at the time of their re-election, has now sunk low. Unless the government acts now, it could well bid its chances of re-election in 2014 goodbye.

You can contact the author on sanjay.singh@citrusadvisors.com

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