In an interview with FE editor MK Venu for Rajya Sabha TV, Reddy who has recently been designated chairman of the 14th Finance Commission added that the new normal for global growth may be less than the pre-crisis periods 3.5%, which was found unsustainable.
Reddy's remarks are a sign of the growing realisation among India's policymakers that the economy's productive capacity at this stage is somewhat strained, an opinion some independent economists had expressed earlier. In July last year, Subbarao has said that India's post-crisis potential growth rate might have fallen to around 7.5%, down from the 8% estimated previously. The GDP growth rate had fallen to 6.5% last fiscal from 8.4% in the year before. The growth was a lower-than-expected 5.3% in the September quarter of this fiscal, which saw a 10-year-low growth in public consumption, and a dismal 5.5% in the previous quarter. The combined efforts of the government and the RBI to spur investment and consumption demand would hopefully bear fruit and the economy may be bottoming out.
India's potential growth rate increased from 6% in late 1990s to above 8.5% in mid-2000s, thanks to gradual but consistent reforms. The feeling that the growth rate of 7%-plus is above potential at this stage is getting strengthened as inflation has been persistently high, even as growth slipped to less than 5.5%.
Reddy said: When it comes to India, I jokingly said sometime back that the new normal rate of growth will be double of the old normal growth rate. The old was 3.5% (up to 70s), so now it is expected to be be around 7-8%. As you know even when (the growth was 9% immediately before the crisis), the RBI did indicate that it is a sign of overheating because the potential output was not that much. Much will depend on our savings and investment balance. The former IAS official widely respected for acumen and refusal to flinch, recalled that many others had not concurred with him when he had said that a 9% growth rate was on the higher side. Governor Subbarao had indicated something to that effect (that potential growth after the crisis is 7.7.5%). Let me put it this way, I am inclined to agree with the present governor of RBI, Reddy said.
According to him, the new normal global growth rate may be less than that in the pre-crisis period, when it was 3.5%, but it led to a boom, and finally, a crisis. Which means by definition it (potential global growth) will not be very much more. But it depends which countries will add to the growth. Secondly, you also have the situation where there is inflation. When the public debt to GDP ratio is high then some burden is passed on through inflation to reduce the burden on the exchequer. Last week, the IMF projected global growth to average 3.5% in 2013, a moderate uptick from 3.2% in 2012, but 0.1 percentage point lower than projected in October. A further strengthening to 4.1% is projected for 2014, assuming recovery takes a firm hold in the euro area economy.
Reddy noted that before the crisis, China entered the global trade with a huge labour force but added that Beijing can't be expected to do the same always. Maybe, India will add (to global trade) but not in the same nature or magnitude (as China did). (There was the) advantage of moderation of prices due to globalisation... There will be lesser advantage in future. So, there is a possibility that the new normal inflation in the global economy may be higher than the normal inflation before the crisis.
Reddy's new book 'Economic Policies and India's Reform Agendas: New Thinking', dwells upon creating subtle creative balance needs to be struck between the financial and the real economy and between global and national considerations. He said: Generally, the idea was that globalisation is successful, there are lot of benefits of that and (that) globalisation of finance is useful. The problem is when a country gets into problem, it is the fiscal policy which has to bail (it) out. So fiscal (policy) has become central in ensuring stability. Than means that fiscal policy is national not global. Then there's an issue that if finance is global, if regulation is national and fiscal is national, then there's a clash.