Saturday, June 2, 2012

Interpreting India's dismal GDP figures

The dismal fourth quarter 2011-12 GDP figures are surely a rude wake up call to India's political establishment. The Q4 rate of growth of 5.3% of GDP is a bitter reminder that the days of Hindu rate of growth are not far behind. The GDP growth rate for 2011-12 declined from 8.4% to 6.5%, the lowest in nine years, on the back of  manufacturing contracting by minus 0.3 per cent in Q4. Over the 2011-12 fiscal, manufacturing grew by just 2.5% while mining and quarrying contracted by minus 0.9%.

The reasons for the sharp decline can be found in the declining consumption and investment figures. The rate of Private Final Consumption Expenditure (PFCE), measured at constant 2004-05 prices, declined from 58.7% to 57.9% of GDP from 2010-11. The rate of Gross Fixed Capital Formation (GFCF) too declined from 32.5% to 32% from the last year.

India faces adverse headwinds on all macroeconomic fronts. Apart from the anemic GDP growth rates, inflation remains persistenly high at 7.3% and is rising; fiscal deficit shows no signs of coming down from the 2011-12 figure of 5.9%; trade deficit has risen to an unsustainable 9.9% of GDP ($184.9 bn) for 2011-12 from 7.1% previous year on the back of steep rise in oil and gold imports; and current account deficit is at 4% of GDP. On the back of all these dismal figures, the rupee has suffered a bruising collapse, depreciating by more than 25% over the past eight months, and has hit historic lows.  

Here are three important lessons for India from the economic trends and outcomes of the past few months.

1. Market confidence is a less-obvious, but critical, driving force behind economic growth, especially in modern economies where financial markets are closely intertwined with the real economy. It enlivens the animal spirits that play a major role in boosting business investment, consumption spending and capital flows. But these animal spirits can be easily spooked by adverse trends like political instability, decision paralysis, market uncertainty, and retrograde policy-making.

Over the past year, there have been numerous events which have adversely affected the market confidence. The political instability following the series of corruption scandals, decision paralysis on coal mining and land acquisition policy formulation, policy flip-flops on retail liberalization and rail tariff hikes, inexplicable retrospective taxation proposals, and failures to rein in the galloping subsidy burden and inflation trends, have all dampened market sentiments. Market participants - businesses, consumers, and financial institutions - have been discouraged from investing, spending, and lending.

Unlike the bygone era, when the connect between politics and the economy was loose, today they are closely interwoven into each other. Political events and trends have the potential to seriously destabilise the markets, weaken business sentiments, and anchor negative expectations. It therefore becomes imperative that the political establishment on all sides exercise restraint and maturity in their pronouncements and actions. The prevailing environment of slippery slope populism and politicisation of every parliamentary debate and policy decision is a sureshot recipe to frighten away the animal spirits.     

2. In a globalized economy, it is difficult to avoid the repurcussions of major external adverse shocks. Any relatively open economy is vulnerable to such shocks. The ability of an economy to tide over such global events and trends is, to a great extent, determined by the strength of its macroeconomic fundamentals and the nature of domestic policy responses.

This becomes all the more important in the context of economies exposed to sudden bouts of capital flow reversals and commodity price shocks. India has experienced the worst of both these trends, with devastating impact on the value of rupee and its external balance. Domestic policy making has to be calibrated to anticipate and respond to such events.

3. The most important lesson is that we cannot take sustained high growth rates for granted. In fact, just a few years ago, it was considered a foregone conclusion that, whatever happens, even with its characterisitic policy muddling, India was irreversibly set on a long period of near double-digit growth.

The events of the last two years have surely put paid to all such claims. It is now clear that there is nothing inevitable about India's economic growth. In fact, if current trends continue, a slip back into the Hindu rate of growth is a very distinct possibility. In fact, as Jahangir Aziz has argued in a recent op-ed, India's "potential" growth is more likely running closer to 6.5%. This necessitates fundamental reforms and massive infrastructure investment push as a precondition for any return to the period of high growth rates.    

It is time for India's political establishment and policy making system to demonstrate the maturity required of an aspiring global economic power when navigating its economy through difficult global economic conditions. Instead of blaming strawmen like high oil prices, high interest rates, and weak global factors, they have to get their act together and stem the plummeting growth rate. While all these issues did contribute to weakening growth, none of them can even remotely explain the magnitude of decline in economic growth. It is macro-governance failure writ large.