Stability of the Indian Economy
August 18, 2011
Current concerns surrounding the Indian economy are not linked to questions about whether the Indian economy can sail through another financial “crisis.” Instead these concerns relate to policymakers’ lack of adequate tools to monitor short-term volatility and the current government’s demonstrated inability to push through significant reforms.
Since S&P downgraded the US’s sovereign rating, many predictions have been made on how this development, coupled with the Eurozone’s inability to confront its debt problem, will impact the global market and, hence, the Indian economy. Past evidence seems to indicate that the Indian economy, largely domestically driven, will remain generally unaffected by another global crisis. Based on this assumption, both the Reserve Bank of India and Finance Minister Pranab Mukherjee have maintained that the Indian economy, though not insulated, will weather any potential turmoil. As a result, policymakers, at the moment, are confident that the latest debt-crisis scare will not affect the Indian growth pattern, and continue to maintain their current GDP growth forecast of 8 percent for the current fiscal year.
Yet despite government official’s public confidence in the Indian economy, growing signs of discomfort in the domestic economy seem to suggest that a global crisis may have more of an effect than officials are willing to accept, both in the short- and long-term.
The short-term discomfort arises from persistently high inflation that has hovered around 8-9 percent, and has remained stubbornly high despite 11 interest rate hikes since March 2010. What is more worrisome is that 27 economists from some of the country’s leading banks have forecast this WPI-based headline-inflation to range from 8.9-10 percent in the coming months, even as policymakers have been repeatedly assuring that inflation will come down in the next 2-3 months.
These trends raise questions about Indian policymakers’ ability to monitor short-term volatility in an economy that has undergone tremendous structural change over the last 20 years, from consumption and production to investment. These changes, though important, question the accuracy, appropriateness and validity of some of the key economic indicators for decision-making. For instance with regard to inflation, the Reserve Bank of India’s Deputy Governor Subir Gokarn has said that the central bank is debating whether higher inflation is the new normal for India. He has also mentioned the challenges resulting from using the Wholesale Price Index (WPI) based inflation numbers to target inflation in India.
This challenge is in part because India does not have a consumer price index (CPI) that properly represents the entire nation, and the RBI uses WPI to monitor its anti-inflationary policies. Similarly, the volatility in the index of industrial production (IIP) data over the past 6 months is analytically surprising. For instance, when the RBI was designing its policy in February, the IIP number available to them was 6.8 percent, whereas the economy was actually growing at around 8 percent. Such trends, according to RBI Governor Duvvuri Subbarao, can mislead policy calculation. This is just one of the issues that confront policymakers in the short run. Unfortunately, finding a solution to this particular dilemma in the immediate future seems unlikely.
Long-term outlooks differ, depending on where one chooses to look. But one thing is certain; India’s reform process, which began 20 years ago, needs another big push. From electricity and labor to land, the un-reformed sectors of the economy have become a drag on growth and if not reformed, could choke long term outlook. Looking at the record of the last seven years of UPA rule, chances of these reforms being adopted may seem weak. The government has been clobbered by a series of scams, has faltered in its efforts to rein in the mounting public deficit, and its plans of reforming the tax regime have been allowed to drift.
In sum, the big concern for Indian policymakers is not just how fears regarding a second global crisis might play out but, more importantly, whether policymakers can find the right mix of policy to rein in the short-term volatility. This mix should include revision in some of the key decision variables and a credible move away from the policy paralysis of the last few months. There have been some indications that the UPA has reached a modus vivendi with the center-right opposition Bharatiya Janata Party (BJP) that would allow several key pieces of legislation to pass during the ongoing “monsoon session” of parliament.
Within recent days, however, the UPA has floundered in its attempts to cope with a renewed anti-corruption protest campaign led by civil activist Anna Hazare, and the BJP continues to pounce on each Government misstep – not a particularly hopeful sign that the two can cooperate sufficiently to secure passage of a substantive legislative agenda. The Indian economy’s fabled resilience has sheltered the country from external shocks in the past. But if the some of these domestic issues are not addressed immediately, the economy may be headed for a downturn that may have nothing to do with the global financial crisis.