Foreign institutional investors – as the money trail seems to suggest – have a fair idea of who is likely to win the 2014 general elections. What is still not known, though, is the winning party’s approach and solutions to many of India’s deep-rooted economic problems.
The economic slowdown in India has now assumed crisis-like proportions and needs drastic solutions. Three entrenched problems – inflation, sluggish investment growth, and the twin deficits – must be the top priorities for the next government.
Priority #1: Inflation, which has sunk deep roots, has now acquired a structural dimension and could well turn out to be the proverbial last straw for the ruling party. It is complicated by the problem of food inflation, which has remained high for some time now, and is one of the main contributors to persistently high headline and consumer inflation. Consumer price inflation for the April 2013-February 2014 period has averaged at 7.8%, and food inflation during the same period is 8.4%. [1] The party that takes the oath will have to put inflation management at the top of its economic agenda.
Unfortunately, none of the manifestos or speeches or interviews by any leader contain any substantial structural solutions. The Congress party seems to have already given up. Its manifesto tacitly accepts high inflation as a fait accompli: “In a developing economy we must accept that when our aim is high growth, there will be moderate inflation.” The Bharatiya Janata Party’s (BJP) half-baked solutions are fuzzy: a price stabilisation mechanism whose workings remain opaque, apart from the usual homilies and trite statements. The solutions proposed by the Aam Aadmi Party (AAP) and the Left, predictably, seem antiquated and heavy-handed – for instance, one of their solutions is to punish hoarders.
Surprisingly, not a single party is addressing the roots of food inflation. First, the multiple layers of middlemen and intermediaries that populate the space between the farmer and the consumer add almost 200% to the farm-gate price. Some tough decisions will be needed here, including tackling the onerous Agricultural Produce Marketing Commission Act. Second, nobody seems to be talking about the capital investment and reforms that will be required to improve India’s agricultural productivity. Another reason for every party’s silence on the issue during election time could be that agriculture is a state subject and nobody wants to start a federal dispute now, especially with so much riding on regional parties.
Priority #2: Resuscitating sluggish investment growth, which is impacting overall economic growth. The heady, plus-9% GDP growth of 2004-2008 was powered primarily by investment growth, particularly from the private sector. That seems to have tapered off: the index of industrial production for April 2013-January 2104 shows no growth, compared to 1% growth during the previous similar period. [2] The immediate reasons for the industrial stagnation can be the multiple scams and court-led investigations, amid allegations of key economic ministries indulging in rent-seeking practices.
The investment drought was further aggravated by the government’s push towards consumption-led growth in the immediate aftermath of the 2008 global financial crisis. This diverted government resources from public expenditure, which typically provides the lead for private investment. Rising interest rates, an uncertain economic environment, and a torpid global economy further added to the hesitancy. The final lid was put by recent legislation complicating land acquisition and rules on environmental clearances.
Associated with the investment problem is the problem of savings, a critical raw material in this case. India’s savings rate has been dropping since the financial crisis. Gross domestic savings dropped from a high of 36.8% of GDP in 2007-08 to 30.8% in 2011-12. [3] This is insufficient to meet the mammoth investment that the country needs to expand its manufacturing base and upgrade its crumbling infrastructure. A high inflation rate is the chief contributor to the dropping savings rate, which has prompted savers to turn to physical assets like gold and property.
The manifestos fail to address this problem, though the BJP does make a token reference to it: “Will encourage savings as an important driver of investment and growth.” Again, the nuts-and-bolts are left to our imagination.
A lack of investment in strategic infrastructure – such as the food supply chain, including cold chains, storage facilities, rural electrification, and proper roads to transport crops to markets and to consumers – has also contributed to spiralling food inflation. Inefficiencies in the supply chain directly add to the cost of delivering food (as well as other goods and services) to consumers.
There is another worrying fall-out: investment, in either manufacturing or infrastructure, has to grow to absorb the millions of youth who are expected to enter the job market every year. A failure to integrate them in the organised sector is a recipe for social unrest.
A concern for employment in the Congress manifesto is reflected in its emphasis on entitlement programmes: for example, Rs. 33,000 crores was allocated during 2013-14 to the National Rural Employment Guarantee Scheme (NREGA). [4] The BJP manifesto, though, has devoted an entire section to employment, which stresses self-employment and entrepreneurship.
But the solutions on offer stop short of tackling the problem. Some of the critical ingredients required are: drastically slashing the long chain of approvals; dramatically reducing rent-seeking opportunities from various government authorities (including state, city and local functionaries); improving the infrastructure; and deepening the pool of trained and healthy manpower.
Priority #3: Managing the fiscal deficit and the current account deficit. Both have an innate relationship with the overall health of the economy. Again, no concrete suggestions seem to be forthcoming. The fiscal deficit is the difference between revenue and expenditure, and the gap is met by borrowing. The fiscal deficit till the end of February had already touched 114.3% of the entire year’s deficit, but revenue inflows during March might help the government meet its 2013-14 target of keeping the deficit at 4.8% of GDP. [5]
The United Progressive Alliance (UPA)-I assumed that social sector schemes (such as NREGA) helped it win the 2009 elections. UPA-II therefore increased not only the number of such schemes but also the outlay spent on them. This enlarged expenditure required a higher borrowing, thereby crowding out resources for the private sector. This also contributed to increased consumption growth and, subsequently, to higher inflation.
The current account is the sum of the balance of trade (exports of goods and services minus imports), net current transfers (such as remittances) and net overseas income. In the past couple of years, the gap between imports and exports has widened to such a degree that even after netting off transfers and overseas income, the current account deficit worked out to a record 4.8% of GDP during 2012-13 [6].
When viewed in the context of tapering by the U.S. Federal Reserve, this proved to be the tipping point for the rupee value. Consequently, it not only vitiated the environment for inward foreign investment, but also increased the domestic price for all imported goods and services, thereby further adding fuel to an incendiary inflationary situation. Although the current account deficit has improved substantially thereafter – and is likely to finish 2013-14 at 2.5% of GDP – it remains vulnerable to volatility in capital flows. [7]
The external deficit needs stable foreign investment, such as foreign direct investment (FDI). While the Congress manifesto is unequivocal about allowing FDI, the BJP manifesto has given rise to a babble of divergent voices. For example, it states that the party will oppose FDI in multi-brand retail, but it welcomes FDI in general. In contrast, the AAP’s manifesto lacks a clear stand on foreign investment.
In addition to these three priorities, in order to address India’s economic challenges, the new government will have to grapple with many other important tasks, including: taking trade to a higher level; economic diplomacy; centre-state relations; an equitable and effective tax policy; a sound agriculture policy; a viable roadmap for infrastructure growth; the unfinished regulatory agenda; rolling out pension reforms; financial inclusion; and the challenges of urbanisation. No government can wave away these problems with a magic wand; sorting them out is going to take time and a lot of effort.
Rajrishi Singhal is Senior Geoeconomics Fellow, Gateway House.
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References:
1. Reserve Bank of India. (2014). Macroeconomic & monetary developments 2014-2015 (An Update). Retrieved from http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/MM01042014D84537B376.pdf
2. Ghosh, R. Government of India, Ministry of Finance, Department of Economic Affairs, Economic Division. (2014). Monthly Economic Report February 2014 (4(3)/Ec. Dn. /2012). Retrieved from http://finmin.nic.in/stats_data/monthly_economic_report/2014/indfeb14.pdf
3. Government of India, Ministry of Finance, Department of Economic Affairs, Economic Division. (2013). Quarterly Review 2013-14. Retrieved from http://finmin.nic.in/reports/QrtReview_june201314.pdf
4. Government of India, Ministry of Rural Development, Department of Rural Development. (2014). Notes on demands for grants, 2014-2015. Retrieved from http://indiabudget.nic.in/ub2014-15/eb/sbe84.pdf
5. Government of India, Ministry of Finance, Controller General of Accounts. (2014). Union government accounts at a glance as at the end of February 2014. Retrieved from http://www.cga.nic.in/forms/List.aspx?Lid=2900&id=22
6. Reserve Bank of India. (2014). Macroeconomic & monetary developments, third quarter review 2013-2014. Retrieved from http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/3_IIITQMMD28012014.pdf
7. Reserve Bank of India. (2014). Macroeconomic & monetary developments 2014-2015 (An Update). Retrieved from http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/MM01042014D84537B376.pdf