Hubris and the story of falling growth

The preparation for elections prompts grand claims by members of the political class. The Aam Aadmi Party promised free water while Narendra Modi bullet trains. The Congress has taken a different tack with one of its leaders claiming that the party has given India the ten best years ever in its history.

Perhaps, being the incumbent, the party cannot only make promises; it must also account for its performance in office. With two consecutive terms, it has had a longer innings than any coalition during the past thirty five years.

Since its claim is about the economy, it comes as a surprise. The Great India Growth Story, which had actually commenced before UPA I was in place, has run out of steam. Today, compared to Year 1 of the coalition, the economy appears worse off. Inflation has raged unremittingly for three years now, the balance of payments had come under stress four months ago, and the growth rate has halved since 2008. If growth and inflation are the macro-economic indicators by which we are to judge an economy’s medium-term performance, what we have witnessed is a somersault, with double-digit growth being replaced by double-digit inflation. (Frankly, there never was double-digit growth --- only the promise of it.)

Economic performance in the past decade cannot really count as satisfactory, leave alone the ‘best that India has had in recent times’. How is it that, having cruised on the turnpike, we are now reduced to chugging along what feels like a gravel path?

The best description of the turnaround would be ‘implosion’, as the situation has been brought about by economic policy itself. The Economic Survey for 2012-13 says over the period 2010 to 2012 growth in India had slowed more than most major economies. Significantly, it had not slowed in the US. Further, of all the countries included in the Survey’s graphics, India has the lowest share of foreign trade. So, it appears reasonable to conclude that the slowing of growth in India is related more to internal rather than external factors.

Examining the recent history of exports and foreign direct investment (FDI) is instructive here. Export growth did show a decline shortly after the onset of the global financial crisis, but was substantially higher since then, in all but one year since 2007-08 -- the year in which growth peaked at close to 10 per cent. This was also the year in which the financial crisis broke out in the US before spreading across the globe.

As for FDI, while the rate of inflow may have fluctuated from year to year, it has been higher in every year since 2007-08. In some years it increased by over 30 per cent. So we find that neither exports nor FDI are likely to have caused the slowing of growth in India.

We are now firmly on home ground, so to speak. There are several factors at play. First, mid-way through the last decade, in 2008-09 to be precise, there was zero growth of agriculture. This was followed by a year of anaemic growth, leaving output yet below its trend. This development triggered an inflationary process that is yet to subside. The actions of the government aggravated an already bad situation. Farm support prices have been raised despite food stocks being much higher than the government-designated buffer-stock norm. In this scenario there was no let-up in the rise in prices.

This also coincided with the introduction and gradual spread of the MGNREGS. Rural wage growth quickened, adding pressure on food prices. Food constitutes a ‘basket’ wider than the cereals, the prices of which are determined by the government. The combination of poor farm growth, the Sixth Pay Commission salary hikes, and the MGNREGS created a permanent excess demand for food. The inflation has, at least in part, been the result of the government trying to shift the terms of trade towards rural producers.

Having to some extent contributed to, if not actually engineered, a higher inflation rate, the Finance Ministry turned to Mumbai for action to control it. A trigger-happy RBI, conscious that inflation control is perceived as its raison d’etre , got into its stride. Mid-way through UPA II it raised the policy interest rate 11 times in succession. This did not curb inflation. But it had a negative impact in another sphere.

It succeeded in bringing manufacturing growth almost to a halt. Inflation driven by supply-side factors, whether in the form of a government raising support prices or of a slow-growing farm sector, cannot be cured by monetary policy. Therefore, India’s central bank would be more socially productive if it were to listen to the repeated concerns over rising interest costs brought up by industry associations, than to its own mantra regarding inflation control.

Here, it would be germane to contest the RBI’s suggestion that inflation is due to the central government’s fiscal deficit. While it is true that the fiscal deficit is higher after Pranab Mukherjee’s stimulus package, it has been declining steadily as share of GDP. It cannot be said the economy is over-heating.

In fact, far from having overheated the economy. the government has very likely contributed to its cooling. It has allowed public investment to decline steadily after 2009. As a share of GDP it is lower in 2007-08, the year in which the growth rate had peaked. This is also one reason for declining private investment, which moves in tandem with the public. In this trajectory of public investment we find a clue to the unravelling of the India growth story.

Over-confident after having come close to breaching the double-digit barrier, UPA II took its eye off growth. If a government spends all its time devising the next rights legislation or imagining yet another welfare scheme, it cannot but give less attention to the productive side of an economy.

The high growth of UPA 1 was accompanied by a record rise in public investment in infrastructure. It is important to state here that this commenced only under the UPA, public investment having been steady under the NDA.

Public investment in infrastructure actually started falling, though mildly, from around 2009-10. This could not but lower growth.