Why has growth fallen off the cliff so quickly
Three things went against us this year. One, in a globalised world, when growth tanks in our major trading partners, it affects us. Exports slowdown in the last few months is very clearly related to the global slowdown, even though in first six months exports were performing very good. We can see that the industrial countries are refusing to grow and therefore, the demand for our products is not picking up internationally.
There are domestic factors as well. One which is deliberate is fighting inflation. It is standard economics that a sharp contraction in demand to pull inflation down has some adverse impact on growth. It will probably lead to unemployment going up a bit. We took a decision which was taken across the board from Reserve Bank of India to the government that in a short-term even if growth goes down a bit, we need to fight high inflation. We want our long-term growth to be high, so we compromised on our short term growth to control inflation. The Reserve Bank of India acted mainly through interest rates and the finance ministry acted through fiscal policy.
Inflation has come down very clearly. Food inflation is now in negative from over 20%. But negative inflation rate won't last too long and in two to three weeks it will remain in negative before becoming low positive.
The third factor where we ought to feel dissatisfied is the slowdown in general, in reforms, in governance and policy slowdown. Well, the coalition politics turned coalition with a vengeance. I don't understand politics very well but it was disappointing to see FDI in multi-brand retail not going through. The other one which I understand but generally people misunderstand is energy prices. Beyond a point you can't shield people by keep energy prices low. You have to shield consumers, poor and vulnerable people. Give them direct benefits but don't try and tamper with prices.
Lack of reforms and slow policy decision are third big factor in pulling the growth down. That is the one where we have some latitude but it depends on your attitude whether you look at political pressure as inevitable, something you can't do anything about, or something we may have been able to handle better.
Do you expect growth to dip even further in the coming quarters
Third quarter will probably be lower than the second quarter GDP growth of 6.9%. I expect not a big but a moderate rebound in the fourth quarter.
Are we prepared for a full-blown crisis in euro zone
While making these statements, I am assuming that the euro situation remains roughly where it is, which is depressed economy but not a crisis. If euro crisis hits us next month, then even this quarter will be hit immediately. So, if euro remains where it is, than I expect the fourth quarter to be better for the reason that services sector never actually did too badly. It held between 9 and 10% growth and is expected to do well.
India's agriculture has never been a great performer but it has grown between 3 and 4%. Its only the industry that did badly, which is very unfortunate. Little bit of calculations and data that I have seen make me confident that we have seen worst of industrial growth and we will see a bit of pick up very very soon. In fact, in the next round of data compilation, we will see IIP picking up.
Do you foresee a break up of euro zone and consequently monetary system crashing
If you ask for my opinion, euro zone will not break up, but there is a reasonable probability that it may break up. If the peripheral countries break off the euro zone, possibly there will be a huge amount of uncertainty. When you create a new currency again; all the promises made in Euro will have to be re-written, initial default will take place because you are re-writing the rules of the game. That will immediately affect big countries like Italy and Spain. French banks have huge exposure to Italian sovereign bonds, so French banks will be hit immediately.
Another thing is that the US does not have much direct exposure to Italy but they have stuck some swap deal, which means you have given an insurance to others who are putting in their money, so, the US has some indirect exposure. If France is hit and the US has indirect exposure, we are talking about India's biggest trading partners being hit badly. What also happens with the financial crisis is the trade finance dries up immediately. That is a scenario we would not like to see. There is a low probability of euro falling. Concerning India, my assumptions are based on the fact that euro remains where it was. If euro situation worsens, it will hit us but possibly India will take the shot better than many other emerging countries.
Will it add to currency volatility
If euro crashes, we dont know what will happen. India's exchange rate policy is good. I completely agree with what we have done, which is if it is a trend driven by market's factor, we just live with it. I know it is hard for some people but it is a fact. But if currency speculators are causing big depreciation, in that case, you expect government to take steps to fight back.
In some ways, we over-reacted to the exchange rate movement. In my view if you look at the two-year stretch, we have been inflating between 9 and 11%, in contrast, the US inflation is at 1%. So, the rupee is loosing value in a way which dollar is not loosing, so you do expect the exchange rate to change to reflect that. What happened is that, this change was not seen earlier. For a long time nothing happened, then correction took place suddenly, so people over-reacted. We have to keep watching, but if there is a sharp correction now, you begin to wonder are speculators stepping up or not. This is a hard game which we have to play.
Will RBI start cutting interest rates now that high growth has tapered off
RBI has given hint that it is at the end of its rate cycle. In my view, now is the time we focus our attention on growth, so we will have to take steps to prop up growth quickly. I think growth will pick up, but we don't want to do anything to damage its prospects.
Where do you see fiscal deficit, which is widely expected to overshoot the 4.6% target
I can't give you a figure but we will miss the target. This is not something we feel very good about; but if there is one year where missing the target will not be such a dramatic tragedy, it will be this year. I would rather like to focus on what is the component of fiscal deficit. We will have to make sure that we are spending deficit not on wasteful expenditure but on investment especially on health, education for poor, human capital, physical capital. I can't speculate on the fiscal deficit number as I am working on it (for the Economic Survey), but the short message is that this year has been a fiscal aberration. We want to go back to the path of fiscal consolidation very quickly.