Sustaining India’s growth

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It is possible that with the correct set of policies we will not only be able to maintain this momentum of high growth into the near future but may be able to raise it to 10%.” This statement by Prime Minister Manmohan Singh, in the face of a world Economy acknowledged to be slowing, is a welcome dose of optimism, and also a challenge. What is the correct set of policies? On the microeconomic front, there is probably considerable agreement about measures that can remove some of the constraints to growth, especially infrastructure improvements that increase operating efficiency. There is less appreciation of the efficiency enhancing impacts of competition, whether in financial Markets, labour Markets or product Markets. Nevertheless, the most difficult issues with respect to microeconomic reform may be political and ideological—the battle of ideas I wrote about a fortnight ago.

In the case of macroeconomic policy, there is somewhat less unanimity among economists, whether it is about exchange rates, interest rates, or capital controls. Monetary policy may not impact long run growth in the normal course of things, but macroeconomic mistakes can have very severe, and possibly lasting, consequences when they disrupt the real Economy. Indonesia, Argentina and other examples illustrate the costs of getting macroeconomic policies wrong. In that context, Indian monetary policy makers are perhaps right to be satisfied with their performance.

In a December 3 speech at Yale University, RBI Deputy Governor Rakesh Mohan said, “The overall macroeconomic record of the Indian Economy since the early 1990s indicates an acceleration in growth and a significant reduction in inflation. Pre-emptive monetary and prudential measures have led to this welcome situation of a reduction in inflation and acceleration in growth while ensuring financial stability.”

The greatest disagreements with respect to macroeconomic policy seem to lie in the realm of exchange rate management. Deputy Governor Mohan stresses concerns about exchange rate volatility, in the context of a domestic financial sector that is insufficiently developed to insulate the real Economy, particularly smaller producers, from the impacts of volatility. A different concern has been with the level of the exchange rate, with some arguing for a bias toward an undervalued rate, to promote export-led growth—the classic “East Asia model.”