By Nitin Desai
The prospects for the world economy look bleaker day by day. The euro zone is on life support and the slowdown in Europe’s economic growth could be even more drastic than current projections suggest. The United States is heading towards a difficult election year, which will mean a postponement of the much-needed budgetary corrections. Japan’s economy remains trapped in a catatonic coma and even China is showing signs of a slowdown. India’s economic growth, too, is slowing to seven per cent or below, though the Indian government is in denial.
Given this starting point, the chances are that we are in for half a decade of slow global growth. Though protectionism has not surfaced in official policy yet, it may not be too far behind given the way politics is evolving in the West. Global financial flows will remain sluggish till foreign exchange and financial markets have settled down, since potential investors in the West sit on cash that they may need at any moment given the fragile state of financial institutions.
In the light of these prospects, the Planning Commission’s 12th Plan (2012-17) goal of nine per cent growth seems increasingly unattainable. To be fair, the approach paper does recognise the “sudden increase in uncertainty about the global economy”. But its projections do not seem to factor in any significant slowdown in export growth or foreign capital inflow. For nine per cent growth, it projects a current account deficit of 2.5 per cent of gross domestic product (GDP), more or less the same as the 11th Plan projected. By implication, this suggests the Plan expects exports to continue to grow at a high rate, as in the recent past. The capital account balance is projected at five per cent of GDP, higher than the 11th Plan’s 3.8 per cent of GDP. In fact, the approach paper states: “It should not be difficult to secure the capital inflows necessary to finance a level of CAD [current account deficit] of 2.5 per cent of GDP, relying on stable long-term Foreign Direct Investment (FDI) flows.”
These numbers may look plausible if one looks at the past. However, the fact is that the global economy may be in for a long period of disruption and restructuring that could upset these trends. Forecasts for the next few years range from the calamitous to the merely pessimistic. Prudence requires that we should work out our sums on the basis of assumptions about exports and foreign capital inflows, which scale down the trend forecasts quite significantly. Please note that getting foreign capital inflows on the scale envisaged in the approach paper will require a more hospitable view of Chinese investments than at present.
This message of caution is reinforced when one looks at what is happening to the growth drivers that the approach paper identifies. The first driver that the paper identifies is the high rate of investment and private savings. The approach requires a further increase in these by about five per cent of GDP. The fact is that these ratios are already on a downswing. The boost that came from the big rise in corporate savings is threatened by the squeeze on profit margins caused by the Reserve Bank of India’s anti-inflationary interest rate hikes and rupee depreciation. Many investment plans have been put into cold storage.
The approach paper talks about the increased openness of the economy, the dynamic outward-oriented private sector, and the flexibility provided to entrepreneurs with delicensing as the other driving force that has unleashed productivity-enhancing competitive pressures. The proposal to open the economy further may or may not materialise, given the current state of party politics and the decision-making paralysis in New Delhi. In any case, the external liberalisation that is pending relates mainly to investment rather than trade; it will not necessarily have a positive impact on the dynamism of the domestic corporate sector.
The broader secular factors underlying high growth, such as improvements in management and labour skills and the aspiration for change, particularly among the young, remain valid but will not compensate for a greatly worsened global environment.
The approach paper does recognise that the 12th Plan will be subject to “considerable short-term uncertainties in the global economy”. But its argument in favour of revisiting the growth targets at the time of the mid-term appraisal seems to be more for raising the target “if the global environment improves, and policy reforms, which could raise the growth potential of our economy, become a reality by that time”.
Bad times require good and realistic planning, which today means a willingness to face the challenge of global economic turmoil rather than wishing it away.
The 12th Plan must be based on a more realistic appreciation of the impending long period of turmoil in the global economy. Planning and investing for nine per cent growth and hitting seven per cent could lead to serious problems such as overcapacity, lowered profitability and non-performing assets in the books of lenders. On the other hand, planning for seven per cent may not necessarily stand in the way of hitting nine per cent, if that becomes possible, provided there is some slack in non-tradeable infrastructure capacity.
Another downside of failed optimism about growth rates could be large errors in fiscal projections, with the government committing resources that do not materialise owing to slower growth. Perhaps it is too late to formally revise the growth targets. However, the revised approach paper must at least work out an alternative with a lower growth rate to identify potential problems.
The other reorientation needed to cope with the worsening global environment is to focus policy reform strongly on boosting growth in domestic demand and not depend on an FDI- and export-led growth acceleration. Measures to boost domestic demand could include programmes to raise productivity and incomes in rural India, logistical and other efforts to bring northern and eastern India more firmly into the high growth economy, accelerating the urgently needed investments in affordable housing and urban infrastructure, improving the competitive capacity of domestic equipment producers, and so on. All this may even be necessary to protect the prospect of seven per cent economic growth.