Economic Survey: Raghuram Rajan reads the riot act to UPA

The induction of Raghuram Rajan as Chief Economic Advisor seems to have injected a note of sobriety in the workings of the finance ministry. If last year's Economic Survey and the Union budget painted a rosier picture of the economy than was warranted, this year's survey, released today to Parliament, is more circumspect about its projections.

Last year Pranab Mukherjee airily projected GDP growth "in 2012-13 to be 7.6 percent, +/- 0.25 percent." We now know that it could be as low as 5 percent.

The finance ministry under P Chidambaram still does not think so, which is why it contested the Central Statistics Office's advance estimates of 5 percent earlier this month.

But the Economic Survey 2012-13 penned by Rajan is realistic and goes with the CSO's estimate of 5 percent. Rajan is clearly not one to have his head in the clouds, despite official compulsion to paint a bright picture.

For 2013-14, the survey makes a GDP projection in the range of 6.1-6.7 percent, and inflation for March 2013 at 6.2-6.6 percent.

Reuters

Reuters

While 6.7 percent would be a godsend, it would be more sensible to work on the lower estimate of 6.1 percent, unless P Chidambaram's budget seeks to give another fillip to growth against the odds in an election year. Clubbed together with the inflation estimate, 2013-14 will be reporting a nominal growth rate of around 12-12.5 percent.

Since the CSO's advance estimates placed current price GDP at Rs 9,461,979 crore, a 12-12.5 percent nominal growth would give us a GDP in the range of Rs 10,597,416-10,644,726 crore. A 4.8 percent fiscal deficit for 2013-14 on that GDP number would be more or less what Pranab Mukherjee had pencilled in last year - around Rs 5,08,000-5,10,000 crore. This gives the finance minister no room to manoeuvre on his fiscal deficit figures for 2013-14. He can manage it only if the steady increases in diesel prices are maintained or even fast-forwarded, and the food security bill does not hog another big chunk of subsidies next year.

Rajan's survey is thus both a warning and a call to action.

The second area where Rajan's hand is visible is in the survey's analysis of why growth is slowing, and why inflation has gone structural. It does not keep blaming only global factors and oil for our problems.

The survey lists three reasons for the slowdown.

First, it blames both the Finance Ministry and the Reserve Bank for it. The survey clearly holds that Mukherjee's post-Lehman stimulus was too much and stayed on for too long. It says: "The boost to demand given by monetary and fiscal stimulus following the crisis was large. Final consumption grew at an average of over 8 percent annually between 2009-10 and 2011-12. The result was strong inflation and a powerful monetary response that also slowed consumption demand."

Second, it indirectly points a finger at the policy paralysis for the slowdown, which, it says, resulted from "investment bottlenecks as well as the tighter monetary policy." The reference is obviously to the extraordinary delays in environmental clearances and government decision-making after the UPA got bogged down in corruption scams post 2010-11.

Third, it apportions some portion of the blame to the global slowdown and the initial weak spread of the monsoon this financial year.

Overall, the survey makes the simple point that India's economic malaise is as much home-grown as external. It notes: "While India's recent slowdown is partly rooted in external causes, domestic causes are also important."

The survey minces no words in telling us that due to the failures of policy and global headwinds, "the consequent slowdown, especially in 2012-13, has been across the board, with no sector of the economy unaffected."

For perhaps the first time in many surveys, Rajan makes a clear connection between policies that create high inflation, and how they ultimately result in a slowdown.

The survey notes that "part of the reason for the general slowdown in consumption could be that higher inflation tends to reduce the disposable incomes of households. Growth of durable goods consumption (under the assumption that growth of consumption for these items would not be significantly different from the growth in production) may have slowed even further recently, because high interest rates and resulting high monthly installments restrained purchases."

The Rajan-influenced survey also explodes another myth that Indians buy gold only for traditional reasons. In fact, it draws a direct link between gold imports and high inflation.

It says that "gold imports are positively correlated with inflation" as "high inflation reduces the return on other financial instruments."

An accompanying study by Rohit Lamba and Prachi Mishra is illuminating. Noting that consumption of gold has shifted steadily to non-jewellery items (which means the rising demand is largely investment-led), the survey says that this trend "is easily explained by the declining real returns on the gamut of financial instruments available to the investor and soaring ones on gold (23.7 percent annual average return between April 2007 and March 2012, versus 7.3 percent return on Nifty and 8.2 percent on savings deposits."

Clearly, while there may be a need to restrain gold imports in order to reduce the pressure on the current account deficit, asking for artificial cuts in interest rates will only worsen the problem and increase the preference for inflation-resistant instruments like gold.

Broadly speaking, Rajan's survey seems to underscore the point that reversing the slowdown calls for fiscal prudence as a first step, but also in pursuing long-delayed reforms that lie outside the budget. At the very least, the focus has to shift from consumption to saving and investment and ending the roadblocks to growth.

The survey says: "The way out (of the slowdown), and the hope for starting a virtuous circle, lies in shifting national spending from consumption to investment, removing the bottlenecks to investment, growth, and job creation, in part through structural reforms, combating inflation both through monetary and supply-side measures, reducing the costs for borrowers...and increasing the opportunities for savers to get strong real investment returns."

The way to ensuring real returns to savers while enabling borrowers to get lower rates lies in lower inflation. Which means curbing excess government spending. In practical terms for government policy, this translates into containing the fiscal deficit, especially by shrinking wasteful and distortionary subsidies. It means working on reducing the impediments to investment such as delays in getting permissions, clarifying difficult and non-transparent processes for land acquisition, and increasing access to good infrastructure such as power and roads. It warrants reworking the regulatory and incentive structure that keeps small businesses tiny and prevents them from creating good productive jobs. It calls for reducing the barriers to entry in various areas of business and allowing FDI, even while ensuring domestic companies are not disadvantaged. It entails providing the incentives and means for the farmer to increase production, even while improving the management and the logistics of food procurement and distribution."

In an indirect way, Raghuram Rajan is saying the government does not have too much leeway in Budget 2013 to throw freebies at the electorate. It also does not think the petroleum subsidies are sustainable, or that the government's Land Bill is any panacea.

Chidambaram may be willing to listen to Rajan, but will Sonia Gandhi?