The Sensex touched yet another all-time high this week. There is continued optimism of investment-led growth and even the more subdued projection on GDP growth by the Prime Minister?s Economic Advisory Council and Planning Commission places growth in the region of 8.7%. It is an indication of the maturity and extent of liberalisation achieved over the past 15 years that growth trends and projections have been ?decoupled? from the political uncertainties arising from the nuclear deal issue. Political events in Delhi create only minor reverberations in the financial capital, Mumbai, or the IT hub, Bangalore. This is particularly impressive because in the balance tenure of this government, nobody seriously expects any new reform initiatives. Not in pension, not in insurance, nor even the financial sector or labour. Clearly, the momentum of liberalisation achieved earlier is considered adequate to sustain the projected GDP growth.
Nonetheless, there are some serious concerns which deserve policy priority. First, we must recognise that India has become increasingly integrated with the global economy with trade as a percentage of GDP having risen from 14.6% in 1991 to 35.9% in 2007, and exports inclusive of services having gone up from 5.8% to around 15% in 2007. Given the current turmoil in the world?s financial markets, the incomplete unwinding of subprime markets in the US and its likely contagion effect beyond the housing sector, a slowdown in the US is a distinct possibility. It is still debatable whether the steps by the US Fed to lower the prime rate by 50 basis points can stabilise markets, renew confidence and rebuild the risk propensity in view of the recent experience. A significant slowdown in the US economy will definitely hurt India?s exports to the most prosperous market, and it is not clear whether a readjustment in the destination strategy of our exporters can be effected in the short-term. Coupled with this, the persistent weakening of the US dollar vis-?-vis all major currencies and the rupee will put increased pressure on our export competitiveness. We also do not know if the dollar has reached its nadir or further adjustments are in the offing. Further, the reduction in US interest rates is expected to generate more capital inflows.
The Indian economy continues to outperform many others, and these anticipated flows will inevitably put pressure on the exchange rate, making some appreciation of the rupee inevitable. The extent to which productivity and efficiency gains by exporters, with no significant innovation round the corner, can compensate for a rising rupee remains debatable. Rigid labour laws circumscribe the space for manoeuvre. The RBI will have little option than more aggressive sterilisation along with a reassessment of our monetary policy. The pronounced sluggishness in exports will hurt GDP growth, export earnings and export-dependent employment, since a significant part is based on labour-intensive activity, much of it in the small and medium sector.
The RBI will have to consider the risk of inflation, given the hardening oil and food prices and other incipient fiscal concerns. An appropriate balance in the pursuit of inflation and growth will need to be struck. Besides, India was not a significant player in what Alan Greenspan in his book, The Age of Turbulence, describes as the end of a disinflationary era, given our labour policy inflexibilities.
Second, given current revenue buoyancies, the fiscal and revenue targets for the current year may be substantially realised, but this masks several deficiencies, the most important of which are the large under-recoveries in the petroleum sector, underpayment for fertiliser subsidies and a much higher food subsidy bill with a significant rise in foodgrain prices due to global production shortfalls. Add to this the contingent liabilities from the possible fallout of the interim recommendations of the Sixth Pay Commission, and other populist expenditure pressures in what will be the last Budget before elections, and the overall fiscal picture begins to look less rosy.
Third, there is no appetite to rekindle stalled reforms. This is true even in areas where mere administrative action is needed. Be it infrastructure, spectrum policy, power reforms, banking and financial sector reforms or lifting FDI barriers, progress is tardy. Action is missing on the recommendations of the National Knowledge Commission. HRD reforms are halting.
At the recent WEF Dalian conference, ?growth hotspots? were a recurring theme with India, Japan and China in focus. On India, there was a general consensus that the hotspots will be the more vibrant states, where a combination of improved governance and investment-seeking will foster competitive federalism rather than competitive populism. In the context of Japan, Heizo Takeneka, a former Koizumi cabinet minister, came up with a new acronym to describe some Asian countries: ?Cric economies?, to represent Crisis, Reforms, Improvement and Complacency. Given the deterioration in some of our exogenous circumstances, India may have entered the ?complacency phase?. Mumbai may have decoupled with Delhi. However, ignoring emerging trends could be costly.
?NK Singh is a former top bureaucrat. These are his personal views