The story of the Indian economy, ever since the recovery began after the 2008 financial crisis, is a story of a few missteps and quite a lot of misfortune. Fiscal profligacy in the early years of recovery and the sustained rise in global commodity prices — food, fuel and metals — partly fired by QE policies of the western central banks, led to extreme deterioration in the current account deficit. This, accompanied by populist food policies of the government triggered an unprecedented bout of inflation in the country, even as domestic demand faced sharp deceleration. Alarms around the balance of payments situation and associated fall in exchange rates only aggravated the stagflationary dynamics (low growth and high inflation). In a nutshell, the Indian economy went off on an unpleasant tangent.
Fortunately, democracy has in-built corrective mechanisms that started to kick in as deterioration deepens. Once the political costs of the status quo (slow growth and high inflation) became greater than the costs associated with tough reforms, the political class responded with tough measures — regular fuel price hikes, power tariff hikes and painful expenditure cuts, among others. Indeed, the historic mandate won by the Bharatiya Janata Party in the general elections of 2014 has a lot to do with the deteriorating macroeconomic backdrop.
As we step into 2015, where do we stand? While it is almost customary to be optimistic about the new year, I am convinced that we are truly at the cusp of the next phase of an impressive economic expansion. And, this phase of economic upturn will be free of the ills of the bloated deficits and double-digit inflation that accompanied the previous recovery. In a sense, it is a ‘Goldilocks’ moment for India.
From the cyclical perspective, the economic recovery is setting in against the backdrop of a very benign commodity price outlook. This is important. The last time around (after the financial crisis of 2008), the recovery was characterised by negative terms of trade shock, which fuelled domestic inflation quite early in the recovery cycle, widened the current account deficit and eroded the margins of businesses. This time, even as growth picks up, inflation and twin deficit dynamics are likely to remain benign, thus allowing the recovery to sustain.
The fact that liquidity conditions have eased considerably and the interest rate cycle is on the cusp of reversal suggest that demand conditions will improve and, de-leveraging will become less painful. Surely, near-term risks arise from emerging weakness in global demand (barring US) and sustained strength in the US dollar. The former can derail the export recovery, while the latter typically leads to rising foreign debt burden, although I must add that so far the rise of the US dollar has been quite orderly.
A more critical aspect of the impending upturn will be the likelihood of it being accompanied by progress in structural reforms. Remember, economic expansion of 2003-2008 happened on the back of ample global liquidity, rather than progress in structural reforms. In fact, our regulatory frameworks such as those for allocating natural resources, acquiring land, etc., were overwhelmed by the pace of economic expansion. As a result, government policies turned more ad hoc and expedient, promoting rent-seeking, crony capitalism and ultimately undermined social welfare. India needs a new narrative. PM Modi’s call for development as a people’s movement is extremely encouraging. It is about cultivating a political constituency for reforms and development. When Margret Thatcher embarked on a privatisation drive in Britain, the slogan was “power back to the people”.
Over the next couple of years, we are likely to see revitalisation of our regulatory institutions — laying down of transparent rules, setting up a level playing field and putting in place apt conflict-resolution mechanisms. These are essential for breaking barriers to entry and encouraging entrepreneurship and competition. On the policy front, subsidy reforms coupled with the drive towards direct transfer of social benefits will go a long way to cutting leakages, fixing distortions and ensuring better social outcomes. The long-pending tax reform, GST, is also at the top of the government agenda, although progress is likely to be gradual given several stakeholders.
No doubt expectations are high, but the opportunity is also historic. Remember, the last time India saw path-breaking reforms (opening up of trade and industry) was 25 years ago and that too under a minority government. I am hopeful that if the policy-makers remain committed to institutions and reforms, India’s growth rate will soon overtake China’s and the size of the economy will cross $5 trillion in 10 years.
