Ensure basic policy reforms to reduce inflation and achieve healthy GDP growth

Ensure basic policy reforms to reduce inflation and achieve healthy GDP growth




By Arvind Panagariya, Professor, Columbia University

Commentary on the Indian economy has decidedly turned pessimistic. While no one has questioned continued growth at 6% or more, nearly all have expressed doubts in sustained growth at 8-9 %. What should we make of this pessimism?

Let us first place the current slowdown in perspective. India had shown remarkable resilience to the financial crisis that erupted in the US in September 2008 and quickly spread to the entire world.

At the time, India had been steadily growing at approximately 8.5% per year. The crisis immediately cut India's growth rate by more than three percentage points, bringing it down to 6.1% during the October-December 2008 quarter.

The following two quarters registered similarly low growth rates of 5.8% and 6.3%, respectively. But then the economy came roaring back, growing at its original trend rate of 8.5% in the following one-and-a-half years.

But slowdown returned in January 2011 with the growth rate dropping to 7.8% in the first quarter, 7.7% in the second quarter and 6.9% in the third quarter ended September 2011. While we still lack the data for October-December 2011 quarter, all signs point to continued sluggishness. What are the causes of this slowdown?

The crisis in Europe is the answer favoured by many, especially government officials. Given that hardly anyone questions the September 2008 crisis as the cause of the slowdown during 2008-09 , this explanation seems plausible.

Yet, data does not support it. The external link to the 2008-09 slowdown was clearly visible in the hit our exports took: they grew negatively, declining at the gigantic annual rate of 15% during the 12-month period immediately following the crisis.

But during the three quarters accompanying the current slowdown, exports have grown at the impressive annual rates of 40%, 32% and 32%, respectively. The crisis has not dented our ability to sell abroad. Therefore, the origins of the current slowdown are to be found almost entirely at home.

One could potentially count many factors but two of them stand out: fiscal profligacy combined with monetary tightening and near paralysis in decision-making at all levels of the government. The former was clearly at the heart of the slowdown in the investment activity, while the latter additionally impacted the utilisation of the existing capacity.

Slowdown in decision-making had initially begun in the environment ministry but it rapidly spread to other central ministries and even states in the wake of the revelation of one corruption scandal after another.

While the slowdown has produced gloom all around, there is an upside to it. Over the years, unprecedented complacency has come to permeate the government, especially the powerful National Advisory Council and the coterie of elite civil society groups that control it.

These latter have come to believe that 8-9 % growth is now theirs to milk and the rapidly-expanding revenues accompanying it theirs to distribute as they see fit.

The slowdown is a powerful reminder that the cost of reckless expansion of expenditure schemes in the name of highsounding 'rights' , which among other things spawn corruption at all levels, is not a minor side effect of the social schemes that may be ignored; instead , it includes the potential to end the growth story itself on which the mega-expenditure schemes are being built.