Government’s Mid-Year Review of the Indian Economy: An Appraisal

The Mid Year review of the Indian economy was placed in Parliament on 23 December 2008. The salient conclusions of the report are the following:

· The overall outlook for the economy is that of cautioned optimism.

· The report forecasts a 7-8% growth rate of GDP for the fiscal year 2008-09

· The fiscal deficit target of 2.5% of GDP in the fiscal year 2008-09 will be missed.

· Inflation rate will ease even further

· It is projected that exports will be adversely affected.

(Source: Review calls for more rate cuts, reforms: Inflation To Continue Fall, Growth To Ease, The Economic Times, 24 December 2008)

This report comes in the background of the global financial crisis which has also adversely affected the growth prospects of the Indian economy. In this context, we have already seen that the Government has announced a stimulus package, which is aimed at strengthening the economy. It is in this context that the conclusions of the report and its recommendations have to be judged.

As far as the issue of growth is concerned, the report is somewhat optimistic because of five main factors in the Indian economy. Firstly, it is said in the report that the share of services in India’s economy is relatively very high compared to other emerging economies. Services are less affected by cyclical downturns compared to manufacturing. This will moderate the negative impact of the global crisis on India. Secondly, it is argued that the agricultural growth rate has been around 4% for the last five years. Added to this, the impact of the NREGA has increased the income and purchasing power in the rural areas. This will maintain the buoyancy of demand in the domestic market. Thirdly, the savings rate in India is quite high which can sustain a higher growth rate of GDP. Fourthly, the ambitious infrastructure requirements laid down in the XI Year Plan will offset any tendency to slow down by increased investment in infrastructure on the part of the Government as well as the private sector. Fifthly, tight monetary policy was pursued for the first half of the year 2008-09 because of rising inflation in the economy. Now that the inflation rate has subsided and is expected to decline even further, the Government or the RBI has got the space to pursue a pro-active monetary policy to sustain growth in the economy. (Source: http://pib.nic.in/release/release.asp?relid=46057)

Based on the above analysis of the functioning of the Indian economy, the following policy prescriptions have been deduced:

• Since, the threat of inflation has subsided, based on a tight monetary policy, the need of the hour is to pursue an expansionary monetary policy. It is argued that the RBI should announce further cut in the different interest rates. The basic logic behind this is that with the loosening of the monetary policy, money supply or liquidity will increase in the economy on the basis of which, demand will increase.
• It has been mooted in the report as well as several other policy documents of the Government, that infrastructure is a very important element in the overall growth strategy. Therefore, it has been argued that all policy and institutional impediments to private sector investment in infrastructure sector should be removed.
• A logical part of the previous strategy is the Government’s advocacy for accelerating all the pending policy reforms. This is supposed to induce the animal spirits of the investors which will sustain the growth process in the economy.

(Source: The Economic Times, 24 December 2008)

Let us now look into each aspect of the abovementioned points. Before going into the policy issues, let us first highlight the problems that are plaguing the Indian economy. As a result of the global financial crisis, the Indian stock market has been extremely adversely affected with FII pulling out money. This has resulted in a crisis of confidence in the Indian economy. In this situation nobody is willing to lend other than to those who have very high creditworthiness. On the other hand, as a result of the credit crisis, two situations have developed. Firstly, the producers are not finding enough credit to finance their investment decisions. Secondly, the prospective consumers, who indulged in debt financed consumption, are not finding credit to sustain their consumption needs. As a result, demand is getting adversely affected both from the investment as well as consumption side. In addition to this, there is the problem of a situation like a liquidity trap, where people prefer to hold on to money and stay liquid rather than indulge in investment or consumption expenditure.

The second important aspect of the crisis in India is the negative effect on the exports. For the first time in many years, Indian exports registered a negative growth in the month of October. This slow down in the exports is because of the slow down in the world market, where the demand for Indian exports has decreased. As a result the export sectors of the country, IT or textiles have been adversely affected. There are reports of massive job cuts in the textile sector and other sectors in the economy which can be directly traced to falling export demand. It is in this overall economic context that the conclusions and policy prescriptions of the mid year review needs to be judged.

Firstly, it is clear from the above that there has been a general problem of demand in the Indian economy, with services also facing a problem of demand. For example, the IT sector, which is the fastest growing sector within the services sector has taken a hit because of the global financial crisis. It is also wrong to visualize the services sector as a homogeneous block, which it is not. While IT is a part of services sector so are housemaids. In case of economic slowdowns it might so happen that people unable to find meaningful jobs crowd in lower end services. This will show itself as a bulging service sector but the well being of the people will hardly increase. So, the argument that since India’s major part of the GDP comes from services and hence the impact on India will be less is misplaced. It should not be forgotten that the advanced countries which are facing the brunt of the crisis have much larger shares of Services in GDP compared to India. Even then these countries have not been spared the threat of recession.

Secondly, the entire question of monetary policy has been exaggerated in the policy circles in India. It is true that there has been double digit inflation in the economy which forced the Government to adopt tight monetary policy. But it is unclear as to how much of the decline in the inflation rate is because of this intervention on the part of the Government. Moreover, as has been pointed out, the crisis today is a crisis of confidence. In this situation it is not enough to merely reduce interest rates, since nobody is willing to take the loans, since the future is uncertain in terms of the person’s ability to pay back the loan, given uncertainty prevailing vis-à-vis job as well as emoluments.

As far as the question of infrastructure is concerned, two points need to be noted. Firstly, it is nobody’s case to argue against infrastructure building in India. On the contrary what is required is much more infrastructure investment. But, there are sectors where the private sector cannot and should not invest, for example, infrastructure in the form of nuclear power plants and other such sensitive projects. However, what is being aimed at in the name of higher infrastructure is complete subversion of these strategic interests. Secondly, it is also the case that infrastructure built by or with the help of private players entails a higher user cost for the consumers. In this case then, a large number of people are left out of the benefits of the infrastructure while private players reap a profit out of it.

The suggestion for even more liberalization of the Indian economy is completely untimely and misplaced. A majority of the problems of the Indian economy today is not in spite of but because of globalization. This is evident from the fact that the problems in the global economy have been imported into the Indian economy as a result of the policies of globalization and liberalization. Even after this, the fact that India has fared better than other countries is simply because of the fact that the Indian economy is not as integrated into the global system as soundly as other countries. The slogan for even more reforms essentially will eliminate this window that the Indian economy has. This is most evident in the decision of the Indian Government to increase the FDI in insurance from 26% to 49%. At a time when the entire financial architecture of the world dominated by finance capital is trying to cope up with its own crisis, the Indian Government has opened up another avenue to import this crisis into India. In the aftermath of this crisis, the biggest insurance company in the world, AIG, went bankrupt and had to be bailed out. In spite of this, our Government wants these companies to have greater stake in Indian insurance companies. As a result any problem of companies like AIG will instantly become a problem of the Indian insurance sector and hence of the Indian economy.

The Government’s biggest lacuna in this report as well as its other responses to the crisis is the fact there has been no concern for the unorganized workers and other marginalized sections of the population who are facing the brunt of this crisis. There is very little or no effort on the part of the Government to put purchasing power in the hands of the poor through higher Government spending. The biggest impediment to this is the FRBM Act. In the absence of Government spending as well as higher purchasing power of the poor, the role of the engine of economic growth and sustaining demand automatically goes to the rich and the corporate sector. Thus if the Government is not concerned enough about the rich and their well being and still wants to ensure higher growth, then it is bound to rely more and more on the rich and the corporate sector. As a result the policies of the Government are aimed at wooing the corporate sector to invest or the rich to consume more. The interest cuts on homes, car loans, the demand for removing all constraints on private sector investment in infrastructure are aimed at precisely this. While this may or may not improve the growth in the country, the poor are clearly left out of its benefits. This is because even the employment generated on the basis of the demand pattern of the rich is low and the infrastructure projects in India more often than not displace the poor rather than provide them with better livelihoods.