Tuesday, September 22, 2015

Indian Economy - The way forward?

As the debate rages on what should be the most prudent strategy for the Indian economy, as it faces adverse global and structural headwinds, consider the following three views. First Dani Rodrik,
Compare China and India. China grew by building factories and filling them with peasants who had little education, which generated an instant boost in productivity. India’s comparative advantage lies in relatively skill-intensive services – such as information technology – which can absorb no more than a tiny slice of the country’s largely unskilled labor force. It will take many decades for the average skill level in India to rise to the point that it can pull the economy’s overall productivity significantly higher. So India’s medium-term growth potential lies well below that of China in recent decades. A significant boost in infrastructure spending and policy reforms can make a difference, but it cannot close the gap. On the other hand, being the tortoise rather than the hare in the growth race can be an advantage. Countries that rely on steady, economy-wide accumulation of skills and improved governance may not grow as fast, but they may be more stable, less prone to crises, and more likely to converge with advanced countries eventually.
So what should policymakers do in such uncertain times? The prudent course would be to hunker down and preserve stability, awaiting greater clarity. rather than turn to policy adventurism. With the sharp decline in India’s inflation, the pressure is on for interest rates to be cut further. The argument is that this would boost both consumption and investment. But money is fungible. The government can easily deliver the equivalent of several percentage points of rate cuts by passing on the decline in global crude to retail pump prices rather than taxing most of it away, as it has so far. This would be the safer option. Cutting domestic rates in the face of Fed tightening unnecessarily raises India’s external vulnerability. More importantly, if the already outsized decline in inflation and input costs hasn’t induced either households or corporations to raise consumption or investment, would a few more basis points of interest rate reduction or its equivalent change anything much?
And, finally, Raghuram Rajan,
Growth has to be obtained in the right way. It is possible to grow too fast with substantial stimulus, as we did in 2010 and 2011, only to pay the price in higher inflation, higher deficits, and lower growth in 2013 and 2014. Of course, India is not in the same situation today. But with the world being an inhospitable place, we have to work hard to strengthen our current recovery and put it on a more sustainable footing. And while monetary policy will accommodate to the extent there is room, we will expand sustainable growth potential only by continuing to implement reforms the government and regulators have announced. These are intended to strengthen the environment for doing business and to expand access to financing, and these will then in turn allow our companies to find and exploit their core competencies...



While we understand the difficulties industry has and will work as hard as we can on improving the environment, India must resist special interest pleas for targeted stimulus, additional tax breaks and protections, directed credit, subventions and subsidies, all of which have historically rendered industry uncompetitive, government over-extended, and the country incapable of regaining its rightful position amongst nations... Jugaad or “working around” difficulties by hook or by crook is a thoroughly Indian way of coping but it is predicated on a difficult or impossible business environment. And it encourages an attitude of short cuts and evasions, none of which help final product quality or sustainable economic growth... The current difficulties of emerging markets stem from a complicated set of reasons, but an important one is impatience to regain growth by overemphasizing old and ineffective methods of stimulus.
So here is my two-pence worth synthesis,

1. India today faces several internal and external structural headwinds and some of the traditional paths to sustainable high growth rates may no longer be open. Our structural transformation may not pan out as expected and may prove quite tortuous.

2. The prevailing global market conditions are adverse and compounds the challenge.

3. India's economy is simply not broad-based enough - consumer spending power, firm capacity, retail and other transactional chains, breadth and depth of credit markets, skilled labor supply, and infrastructure capacity - to sustain high growth rates for longer durations. The weak state capacity and various land, capital, and labor market distortions only exacerbate the problem.

4. So a more prudent strategy may be, as Dani Rodrik says, to be the "tortoise", or as Jahangir Aziz says, to "hunker down", and brace for 5-7% medium-term growth rates and expedite important long-term reforms in health, education, labor, credit markets, taxation, and most importantly, in improving state capability. Simultaneously keep investing in infrastructure so that the stock builds up and deficiency shrinks. If done as planned, hopefully, over 4-6 years, we can reach where China was in 2001 and then take-off in a more sustainable manner.

As a strategy, policy makers and political leaders may need to acknowledge this reality, while pursuing the strategy of talking up the markets. The latter is necessary not just to win elections, but also to signal to the financial market participants. But the former is where substantive action should take place. The "island of relative calm in an ocean of turmoil", as the RBI Governor described the relative state of Indian economy, and the window of opportunity that it presents may not last for too long. 

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