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Column : The interim puzzle

Feb 18 2009, 02:03 IST
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SummaryAs economists we hate to be wrong, which of course happens with uncanny regularity, but there are these rare occasions when we want to be proven wrong.

As economists we hate to be wrong, which of course happens with uncanny regularity, but there are these rare occasions when we want to be proven wrong. Like many, I did not expect any significant announcement in yesterday’s interim budget, although I was hoping that there would be. Belying such hopes, the government presented a budget that stuck to the traditional framework of a standard vote-on-account. So until a full-year budget is presented, probably in June, the government’s policies and spending programmes will follow the direction set by last year’s budget and the policy changes contained in the December and January stimulus packages.

There is much to be said for respecting institutions especially these days when the norm is to flout them. But was it the right thing to do or just the easy option? The government could have chosen to invoke the current extraordinary global economic situation and provide the economy with added fiscal support. Few could have argued against it. After all the current global recession could end up being worse than the Great Depression! Assuming that the government did not take the easy route, we are left with the alternative explanation: the government does not believe that the downturn is going to be as severe as many fear and that the stimulus provided so far can keep the economy going through the next few months at a fairly decent clip.

This is worrisome. It isn’t that the stimulus contained in the December-January packages and its extension in the interim budget is small. By all accounts it is large, running between 1-1.5 per cent of GDP stretched over 2 quarters. The concern is that it may be too little compared to the economic slowdown. If the RBI’s pause in the monetary easing cycle at the January meeting and the government’s decision to push additional fiscal support to after the elections is based on the belief that growth will be 7 per cent this year and next, then things are far worse than they look. And how they look is not pretty either.

The CSO’s advanced estimate for GDP growth for this fiscal year (ending March 2009) is 7.1 per cent. The market consensus is 6.8 percent and there are several others like me who believe the outturn will be much less. Forecasting economic turning points is a difficult job but it is especially so if it is overly based on historical patterns, which tend to underestimate the severity of a downturn and the pace of an upturn. Over the last decade, India’s advance GDP estimates have been prone to significant revisions. The margin of such revisions tends to be largest when the economy either slows down sharply or picks up abruptly. For example, in the 2000-01 downturn, when growth in the last quarter fell to 1.8 per cent, the advanced estimate was 6 per cent. Eventually the economy registered a 4.4 per cent, a revision of 1.6 percentage points! In the 2005-06 upturn, when growth in the last quarter shot up to 10.3 per cent, the CSO advanced estimate was 8.1 per cent, underestimating growth by 1.4 percentage points. If this pattern is repeated then we might be in for a very large downside surprise.

Methodology aside, contracting industrial production, negative bank credit growth, falling vehicle sales, slowing rail and port traffic, and possibly a substantial fall in exports and imports in January all point to a sharp economic slowdown this quarter. The problem is that we won’t know how good or bad this quarter was till much later. And at that time the needed monetary and fiscal stimulus might be excessively large.

My guess is that both the monetary and fiscal authorities are fully aware of these developments and that their policy stance is based on expecting the worst and hoping for the best. To be sure, the RBI in its January policy statement underscored the “amplified” downside risks facing the economy, while the acting Finance Minister in the budget speech talked of the same and the need for additional support in the full-year budget.

So I am choosing to infer that the pause in the monetary easing cycle was tactical to preserve policy space to be used in the coming months when India will hold elections. And postponing additional fiscal stimulus till after the elections reflects the government’s strategy to balance support to the economy with limiting the impact on the deficit. With public debt around 80 per cent of GDP and little scope of credibly committing to a divestment strategy in the present political context, it was perhaps wise not to go for a larger implied deficit, especially as market nerves are already frayed by last week’s announced size of bond issuance for this fiscal year.

What about the numbers underlying the budget? It makes more sense to talk about them in the June budget. Meanwhile, all eyes will be on the RBI’s next move and the pace of implementation of the stimulus contained in the December-January packages and its extension in the interim budget

The author is chief economist for India, JPMorgan Chase. These are his personal views

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