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Indias economy story: There is hope yet

(By:Alok Kumar,NIT ROURKELA)



The three biggest problems that plague our economy today are decelerating economic growth,
rising inflation, and a widening current account deficit (now at 4.8 per cent of GDP). These
problems have the combined effect of lowering investor confidence (both domestic and foreign)
and falling rupee value against the dollar (reaching a low of 61.09). It is also important to note
that these problems turn into a vicious cycle, as lower investment confidence means FII flows
leave the country, depreciate the rupee, which in turn raises import bills widening the current
account deficit and further hurting confidence. On June 12, Fitch Ratings downgraded our
outlook from stable to negative, something Standard and Poors predicted months back. Instead
of merely stating the problems, this article seeks to break these problems down to specific
causes and further explore possible policy solutions, keeping in mind the political constraints and
upcoming the General Election.
India grew at 8.5 per cent in FY 2010-2011, which has now slumped to 5 per cent in the most
recent fiscal year ending March 2013. Breaking these numbers up into the three sectors of the
economy manufacturing, services and agriculture is key in understanding the cause of
decrease in real GDP growth.Agriculture and manufacturing have seen a significant slowdown in
this period of three financial years going back to March 2010. Agriculture growth has gone from
7.9 per cent to 3.6 per cent to 1.9 per cent while manufacturing growth has fallen from 9.7 per
cent to 2.7 per cent to 1.0 per cent. The services sector has driven most of the current growth
level by remaining relatively stable in this period. In the given period, the growth in services has
been between 7.5 per cent and 9.5 per cent, which are healthy rates of growth. So our policy
decisions have to be focused on manufacturing and agricultural growth through structural
changes which will help revive economic growth in the country and restore investor confidence.
The long term effects of a dramatic slowdown in manufacturing and industrial production is also
evident in the Gross Fixed Capital Formation falling from 14% to 4.4% to 1.7% in the last 3 years.
This is an often ignored indicator, but crucial for measuring sustainable growth and structural
development of the economy.
So the question that arises is how can manufacturing growth be enhanced through
macroeconomic policy decision making. A demand side approach by stimulating the economy
through interest rate cuts (made by the RBI) seems unfeasible given the current levels of rising
inflation. The problem is clearly one on the supply side and hence investment in the domestic
economy has to be facilitated through government incentives (and good governance) and smart
management of the fiscal policy. Investors looking to set up industry units, are primarily looking
for three things in an economy. A strong infrastructure (water, energy, transport and
communication systems), policy and political stability, and low levels of government intervention
through minimal red tape and bureaucracy. It is these three factors that create the right
environment for industry and entrepreneurship to flourish, which will most importantly address
the dearth of jobs in our economy.
A strong infrastructure growth means major reductions in supple bottlenecks that have been the
cause of inflationary pressures on the economy. The creation of a good infrastructure is
something that does not need political approvals in Parliament and hence coalition politics plays
no role in this. The present Government needs to get out of the mind set that says foreign direct
investment is the only means by which this can be achieved. Infra development is something that
can be achieved through banking reforms that will give investors better access to credit. Another
option is reallocating some of the funds, given as freebies under the veil of social security and
rather use that money on infra projects that would create more active jobs. The subsidy bills
today have skyrocketed and are clearly unsustainable in the long run and hence the market rates
of petroleum-related products should be allowed to increase in increments reflecting its true
prices. These policies might be unpopular amongst the people and hard to implement in light of
the upcoming elections but they are important to move towards fiscal responsibility, something
that Mr Chidambaram pledged in his last budget.
Two very clear cases in the last few years threaten the idea of policy stability in India. The
retroactive taxation of Vodafone after an arbitrary change in tax laws and the approval flip-flop
of the Jet-Etihad deal have meant that foreign and Indian investors are losing confidence in the
governance policy of India. Indian Government and policy makers have to look at the long term
implications of such actions in terms of driving investment out of the country hurting investment
confidence. A foreign investor recently remarked, Ive seen policy changes when the
government at the center changes, but never seen policy changes with the same government!
By stable economic environment, investors also expect stability in interest rates, inflation and
currency values, something that the current government at the center has failed to control
through effective policy. Simple solutions like inflation targeting (successful precedents in
countries like Brazil, where inflation was at unsustainably high levels) can help bring stability in
current conditions.
Today, it takes an entrepreneur around 30 days to start a business and around 49.8 per cent of
the current GDP per-capita (around $600) in legal costs according to the World Bank. In this
indicator called ease of doing business, we rank 132nd which is the lowest amongst all BRIC
nations, which shows why investors are beginning to look away India as a suitable destination for
their capital. Significant changes have to be made to ensure quicker approval systems and better
credit access. However, regulation carried out by organisations like SEBI should remained
unchanged as this was responsible in keeping the Indian economy relatively insulated from the
recent global crisis. Again, the changes required are systemic and structural in nature and
something that is unaffected by the all-important political variables.
Agricultural reform is something that has been another well discussed subject. This subject
remains an important to India because we are still very much a consumption-based economy
and this sector still accounts for 53 per cent of the employed labour force. The Financial Express
released an excellent article on 27 February, 2013 highlighting some of the policy decisions that
can help restore growth in this sector to 4 per cent. Some of the measures include revamping
the Public Distribution System (PDS), improvement in food stock management to reduce
wastages, and more investment in skill development and R&D for better scientific management
of crops. Agricultural growth is critical for an improvement in the income of farmers and fueling
export growth since we produce surplus which can be used in world markets.
Many people talk about the structural changes and policy reform we need to make in the near
future. Something that we do not need to change, is the services sector. This has been the best
performing sector in the economy and has remained relatively unaffected by the recent crisis
period. BPOs and IT are the two industries that have continued to grow at a steady rate. Mr.
Deepak Parekh, Chairman of HDFC Bank, stated at a recent Citizens for Accountable
Governance (CAG) conference that, Every job created in the IT industry leads to the creation of
3 additional jobs in ancillary industries. It means that by 2020, the 3 million direct jobs created by
the IT industry will lead to 9 million indirect jobs in the economy.
This article has taken a sector wise approach with a special focus towards stimulating
manufacturing and industrial output, which remains the need of the hour. There has been a lot of
pessimism in the media lately about the India growth story. However, I remain optimistic given a
certain degree of policy enactment and reform is implemented. We have a relatively young
labour force, (similar to Chinas in the 1980s the period when its economy really took off) but
this demographic dividend presents a short window of opportunity. A supply side approach with
a focus in increasing output in the manufacturing and agriculture sectors can bolster economic
growth, cut inflation and promote exports through excess production for world markets. A
creation of jobs which will constitute demand in the labour markets has to be complemented with
extensive programs in education, skill development and increased employability/productivity
through tertiary education amongst the youth. This article lists a host of reforms, which is not
exhaustive, but does include some important structural changes that can be implemented without
the problems of coalition constraints and political considerations for the upcoming general
elections.
ALOK KUMAR

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