Tuesday, March 12, 2013

Realism and Reform: Re-Balancing Optimism and Pessimism


When I read what politicians are saying and reportedly thinking, I am afraid that, as in 2009-10 they will once more become too complacent and ignore the need for continuing reforms over the next three years (not just this year), and permanently loose the opportunity of restoring growth  to its medium-long term potential of 8% to 8.5%.  When I talk to people from the World of Business and Private Equity (the long term investors) I often find a deep despair about a host of government actions and inactions that have stymied growth of output and investment in the recent past.  I fear that their pessimism will slow the pace of recovery even if the political system produces genuine reforms of the “permit-inspector raj”.  Both the over-optimism among politicians and the excessive-pessimism among business and industry can be bad for economic recovery.  We need a realistic balance between the two, if we are to get both a reasonably quick and a sustained recovery.

Reasons For Pessimism

Two numbers from the Economic survey, encapsulate the negative story for 2012-13:  One is the Current Account Deficit (CAD) of 4.6 per cent of GDP and the other is the growth rate of Gross Domestic Product at constant market prices (GDPMP) of 3.3 per cent.  These are both unprecedented and unsustainable numbers.  The growth projection of 5 per cent for GDPFC that shocked many observers, is 1.8 per cent point higher than the number for GDPMP.  We last had such a low growth rate for GDPMP during the BOP crises of 1991-2 when it plummeted to 1 per cent.  The CAD of 4.6 per cent has no historical precedent; the worst historical CAD was 3% of GDP in 1990-91 when the BOP crises started.  The high inflation rate, best captured by a five year average 9% rise in the implicit GDP deflator for private consumption, is another symptom of macro-economic imbalance. However, it is still lower than the nine year average of 9.9% from 1990-91 to 1998-99.

Parallels With BOP Crisis of 1991

Despite underlying imbalances that are arguably worse than in late 1980s, there has been no crisis this time.  The reason is the foreign exchange, trade and capital account reforms of the 1990s, which have allowed the economy to adjust without blowing up into a full-fledged crisis.  But the underlying problems still need to and must be addressed if they are not to act as drag on the economy or lead a BOP crisis a decade later.  Fortunately, because of the 1990s reforms, we now have more time to address them.  These reforms proved that a combination of “macro rebalancing” and “structural reform” could correct the macro imbalances and bring us on to a higher growth path than the 1980s. The former involved a classic (fiscal) expenditure reduction cum expenditure switching policy of real depreciation, which got us out of the 1990 BOP crises.  Intelligently adapted to current economic conditions, including a much more open economy, it can still bring results. In this context, policy actions to facilitate short term external financing of high CADs and increase nominal appreciation, are misdirected.

Reasons For Optimism

The Indian economy looks better from a medium term global perspective.  India is currently one of only seven countries (out of around 250) in the World with an average decadal per capita GDP growth rate of over 6% (2003-2012).  The ratio of India’s GDP growth to the growth of World GDP shows virtually no trend since 1994 (figure).  In other words India has maintained its growth performance relative to the World economy since 1994, even though in any given year it may have performed better or worse (as in 2012).  Similarly the ratio of the Indian Economy’s growth rate to that of China’s has been on a rising trend since 1994, as China’s growth slowed relative to the World economy.  This trend rise in India’s growth rate relative to China’s is very modest, from about 60% of China’s rate in 1994-1995 to about 80% in 2011-2012.  From this global medium term perspective, 2012 is a bad but not unprecedented setback, from which we can still recover if we take the necessary corrective steps over the next three years.

Policy, Regulations And Institutions

There is need for policy, regulatory and institutional reforms.  Part of the extreme business pessimism stems from the fact that one of our most cherished beliefs, since the 1991 reforms, has lost its credibility.  When reforms slowed after the initial burst in 1990s, we (in the MOF) used to tell foreign investors that the pace of reforms and the sector preference may vary with every government, but no government including the left front, had reversed any reform.  Gradually at first, then more rapidly, negative practices of the old “license-permit-inspector raj” have returned, in sectors/areas still under the control of the government.  Whether this happened inadvertently or deliberately, it has affected both domestic and foreign investors in the real economy and is a factor in the investment collapse.  It needs to be corrected through regulatory and institutional reforms.  Don’t be misled by the FIIs lack of concern on this score, as short term investors are quite happy to profit from the high interest rates relative to US, Europe and Japan and finance the high CAD for now.

Realism And Reform

In conclusion the Indian economy is not in as bad shape as investors in the real economy think nor is it as good as many politicians and political advisors think.  The government must not abandon (at the first sign of recovery), its efforts to correct the imbalances and bottlenecks that have arisen.  The real economy investors must shed their pessimism, as government makes genuine efforts to restore growth, and start investing. More realism on the part of both can return the economy to the long term growth trend more quickly.
A version of this article appeared on the editorial page of, The Indian Express on Wednesday, 13th March, 2013, under the banner, “Two Stories of The Economy,”  at,


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