At the heart of the story of resilience is the strength displayed by domestic consumption demand. The severity of the crisis in the West resulted in a massive squeeze in exports, some 14% of Indias GDP. While exports may have recovered a little at the fag end of 2009, there still isnt much to cheer about given the slow speed at which the West (our biggest export market) is recovering. Investment also took a hit in the liquidity crisis and in the crisis of confidence that followed the collapse of Lehman, and continued into early 2009. Still, the loss in investment was relatively small, and corporate investment plans have revived in the second half of 2009. The government did its best with a fiscal stimulus, but Indias fiscal stimulus was small when compared even to Chinas. That leaves relative buoyancy in consumption demand to explain the better than expected GDP numbers in 2009. The role of rural demandpropelled by higher support prices to farmers, spending programmes like NREG and even loan waiversin keeping the economy growing was particularly noteworthy. That is why the rural consumer is FEs person of the year. Also, contrary to the doomsayers, there was no drought. There was admittedly a differentially distributed monsoon, but it did not hit agriculture as badly as a proper drought might have. In any case, a slight slowdown in agriculture now has limited impact on the broader macroeconomy.
Interestingly enough, much of the resilience in consumption and the recovery in investment happened despite RBIs relative conservatism on interest rates. Sure, RBI cut rates from the peak levels of 2008, but compared to the rate cuts enacted elsewhere, RBIs efforts were simply not enough. Couple the conservatism in monetary policy with excessive conservatism on financial reform, and we ended up with a situation where bank lending was still too expensive. Big firms used alternative sources of financing but there wasnt anywhere to go for the small business and the aam aadmi. RBI may claim some credit for keeping the Indian financial system safe, but unless the financial system also delivers cheap finance to a large number of stakeholders, safety has little meaning. In the last couple of months of 2009, RBI has been too distracted by the spectre of food inflationundoubtedly a supply-side problem, for which monetary policy has no solution. Still, RBIs distraction ensured that the debate on interest rates shifted to exit strategy mode much earlier than it ought to havesome more monetary accommodation may have led to better growth numbers. As we have argued repeatedly in these columns, there is no sign of conventional overheating in the economy, even now. One of the things to watch out for in the early months of 2010 will be how RBI tackles the twin issues of monetary policy and financial sector reform.
However, RBI was not the only institution responsible for a lukewarm policy response to an unprecedented crisis. The government, while doing its bit to promote fiscal stimulus, has clearly not done enough in terms of giving the economy a reforms stimulus. As we move into 2010, it is clear that both monetary and fiscal stimuli will be withdrawn sooner rather than later. After that, whether the economy can maintain its 7% momentum and ideally move back up to 9% trend depends on the kind of economic reform measures the UPA-2 enacts. The government was obviously not in a position to push key reforms before the general election. But after receiving a fresh mandate, and without the baggage of the Left parties, UPA-2 had the perfect opportunity to give new thrust to economic reform. The government has proceeded, even if slowly, on disinvestment. But it has made little progress in terms of enacting crucial reform legislation (pensions, insurance, companies Bill, land acquisition Bill, among others, are still pending) in the two sessions of Parliament after the general election. Perhaps the biggest policy challenge for the government in the coming year will be to sort out the tricky issue of land acquisition. If stalemate continues, the prospects for building infrastructure and manufacturing facilities will be dented. If 2010 is to be the year the economy recoversthat is, gets back to 8%-plus growththen policy stimulus has to play a much bigger role than it did in 2009.