Editorial✍ Live Mint Prelims cum Mains

Indian economy in a better place but challenges remain

Interim budget in February:
  • The current central government will present its last budget on 1 February.
  • It will be an interim rather than a full budget. The interim budget will likely be the last macroeconomic policy statement by this government before the 2019 Lok Sabha elections.
Situation before 2014:
  • The present government took office at a time when the Indian economy was still recovering from the macroeconomic policy errors of its predecessor.
  • High inflation, high fiscal deficits and high current account gaps had led to a run on the rupee in the middle of 2013.
  • It was only then that efforts were made to tighten policy and the Reserve Bank of India (RBI) had also begun to increase interest rates.
Looking back at the macro strategy over the past 5 years:
  • This is a good time to look back at the macro strategy (and not the economic reforms record) over the past five years.
Macro stabilisation:
  • The focus was on fiscal discipline.
  • The Indian central bank was also given a formal inflation target.
Strengthening public finances using the fall in global oil prices:
  • Global oil prices collapsed in the dying months of 2014.
  • India got an economic boost from this positive shock to its terms of trade with the rest of the world.
  • The government used this opportunity to strengthen public finances through tax hikes on fuel.
  • The improvement in net exports provided a temporary boost to economic growth.
Inflation management:
  • The RBI was also focused on its stiff inflation target.
  • Headline inflation halved over the tenure of the Modi government.
  • Hikes in minimum support prices were modest till 2018.
  • Indian inflation is now closer to global inflation.
Overall the macro stabilisation worked:
  • India is in a far better place today than it was six years ago if one looks at the three main indications of economic stability—
    • Inflation
    • Fiscal deficit
    • Current account gap
  • Critics say recent macro economic measures negatively impacted growth rate:
    • There is no shortage of critics of the economic policy pursues over the last 5 years.
    • They argue that India needed some combination of higher fiscal deficit and lower interest rates to push economic growth.
  • But this policy was forced by the poor state of economy by 2014:
    • The policy choices over the last 5 years have to be seen against the backdrop of what happened prior to 2014.
    • By 2014, India’s growth story got so muddled that India was seen as one of the fragile five (five most fragile emerging market economies).
  • The focus on macro stability was welcome.
But structural issues remain in the economy:
The more persistent worries for Indian economy are structural.
  • Fiscal Deficit: The combined fiscal deficit is inching up.
  • Investment: Corporate investment seems to be recovering but is still weak.
    • There were also deeper challenges to be addressed.
    • India was depending too heavily on private consumer spending.
    • Corporate investment had fallen off a cliff because of excess capacity, balance sheet stress and weak banks.
    • Economists had argued that the government needed to boost public investment to fill the gap created by weak private investment.
    • The oil bonanza had provided the fiscal resources, but public investment did not take off in a big way.
    • Private investment continued to struggle.
  • Savings: The savings rate is too low to support a robust investment recovery.
    • The sharp decline in the domestic investment rate helped reduce the current account deficit (which can also be read as the difference between domestic investment and domestic savings).
    • The improvement in the current account masked the fact that the domestic savings rate has drifted down over the past decade.
    • There could be external stress in case investment cycle turns without an improvement in the savings rate.
  • Exports: Export growth is sluggish despite the recent synchronized recovery in major global economies.
    • A narrowing trade gap combined with strong capital inflows pushed up the rupee, despite dollar buying by RBI.
    • The overvaluation of the rupee was one reason why exports stagnated.
    • Foreign demand for Indian goods was not strong enough to balance weak domestic demand.
    • There was an opportunity after world trade began to recover in early 2018, but that was just when Indian supply chains were disrupted because of demonetisation followed by the transition to the goods and services tax (GST).
  • Capital with banks: The bad loans crisis may have peaked, but banks will need a lot of capital.
    • Twin balance sheet problem:
      • There was not enough done to deal with the twin balance sheet problem.
      • Twin balance sheet problem refers to the problematic balance sheets of Indian companies and banks—meaning, both the lenders and borrowers are under stress.
        • Companies have too much debt and little money to repay.
        • Banks are under stress due to rising NPAs and they are unable to issue fresh loans.
Growth rate needs to be higher:
  • The growth rate that can be sustained without macro instability is still below its level a decade ago.
  • India is one of the best performing major economies in the world.
  • The question is whether that is enough to create the income growth as well as jobs needed for a stronger assault on poverty.
  • The Indian economy is far more stable than it was when nearly five years ago.
  • Yet, some of the deeper structural challenges to economic growth are still present.
GS Paper III: Economy

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