The annual meetings of the International Monetary Fund and the World Bank have concluded on sober notes. The global economy is weak, and recovery is uneven and subdued than anticipated. More importantly, new policy challenges are emerging and policy spillovers may emerge. While it is perceived that the interest rates in US could be at a turning point, the activity in the emerging markets (EMEs) is slowing and asset quality is deteriorating. In the meantime, the financial system in the euro area continues to be weak and public debt in many advanced countries continues to be high, implying that EMEs are facing tighter global markets. Growth in the euro area is also restricted because of weak economies in the periphery. As funds would move back to the US, given that recovery has begun, countries which are fiscally weak and suffer from high inflation would be most exposed. The IMF warns that during this period of transition, EMEs are most vulnerable.
The alarm bells for India are very shrill. The downward adjustment of 1.8% in the growth rate of India is the largest for any single country. The growth forecast for 2013 has been reduced from 5.6% projected in July to 3.8% in October. It is understandable that in an election year, the incumbent government had to show a bright growth trend to its domestic constituency but truth had to prevail finally. But drastic scaling down of growth by a multilateral agency does not augur well for India?s policy makers.
According to the IMF, India?s growth potential has been impacted because of infrastructure and supply bottlenecks arising from problems in mining, energy, telecommunications; slowdown in permits and project approvals; and over-stretched corporate balance sheets. Also, given that current account deficit (CAD) is large and inflation is high, monetary policy options are limited in the face of decelerating growth.
In this grim global economic situation, and difficult export markets, expecting that BRICS would not compete with each other would be unrealistic. In addition to growth challenges that China faces, given that more than $ 2 trillion of China?s reserves are invested in the US, the bonding and loyalty towards BRICS may not be a realistic assumption. Brazil also has its share of economic difficulties and fiscal risks. Therefore, every country will have to fight its own battle in the current scenario.
In general, the policy makers would need to take some difficult decisions. First, to address the supply side constraints in view of inflationary pressures, should interest rates, impacting overall growth, be raised? Second, in view of global uncertainty, should the authorities defend the exchange rate or let it gradually move with the fundamentals? Third, in view of the slowdown in growth, revenue receipts will suffer and fiscal indicators will begin to look grimmer, restricting space for social spending. In view of the fact that overall fiscal deficit of the government is very high in India, to avoid any further deterioration, new schemes, like the food security bill, may need to be reconsidered. Finally, there is urgent need to undertake structural reforms to increase productivity and boost competitiveness, proceed with the stalled projects, and incentivise sectors like infrastructure, housing and automobiles that can spearhead growth.
On specifics, like the advanced countries, there is need to think unconventionally, boldly and out of the box. The import restrictions on gold may have been successful in curtailing the CAD for now but as purchase of gold has religious significance especially during the festival season; smuggling has substantially increased in recent months, according to reports. Rather, illustratively, given that 18,000 tonnes of gold is stocked with households in India, equivalent to about a trillion US dollars at current exchange rates, this could be used as a fiscal resource and India should consider instruments like gold bonds or asset backed securities on gold.
On energy, distribution and transmission losses on electricity are still estimated around 20% which needs to be curtailed. In view of the problems in the domestic mining sector and consequently substantially high imports of coal, a simpler and immediate solution could be demand management. In addition to steep pricing, as is the practice in many advanced countries, official business hours for commerce should generally be limited to day light. Illustratively, even in the US, shopping areas have designated business hours. Though some individuals may, but a developing country like India cannot afford inefficient use of scarce energy, on unlimited working hours, especially during difficult times.
In an election year, transparently acknowledging the grim global situation would be a challenge for any government but is in interest of the nation. A clear communication and open dialogue will prepare citizens to encounter the difficulties confidently.
The author is the RBI Chair professor at IIM-Bangalore