There has been much fretting about Standard and Poor’s downgrading of India’s country rating on Wednesday, but haven’t we been doing everything to deserve it? High inflation, unsustainable fiscal and current account deficits, no reforms, low business confidence, and an atmosphere of policy paralysis.
It seems we are still living in the “golden age” delusion: we believe that the 8.5 percent GDP growth average we achieved during 2003-11 was no fluke. It was ours by right.
We did very little reform during those years, but this only reinforced our belief that we don’t need reforms to push growth. It can all come from the golden goose called demographic dividend – which we are eager to see laying more eggs without food or nutrition.
Well, here’s a wake-up call. The years of plenty are over. We are now up against five to seven years of lower growth, and we are still deluding ourselves that we will get 7.3 percent or something even better this year.
My prediction is that we will not get above 5.5-6.5 percent GDP growth on an average, and anybody who thinks otherwise will have to explain why they think we will manage this miracle when we have squandered every piece of good luck thrown at us: good monsoons, big revenue bonanzas from the 2010 telecom auctions, and a global slowdown in 2008 that simply brought commodity prices down suddenly.
The truth is our growth of 2003-11 was largely due to global liquidity trends and luck. It had nothing to do with what we did to lift ourselves up.
I base my lower growth trajectory argument on our past track record – when the international environment was much better, but we still never achieved anything like what we did in the last eight years.
This is what the numbers show: in the six years from 1985-86 to 1990-91, the economy grew by an average of 5.6 percent. In the next six years (1991-92 to 1996-97), which included the glory years of Manmohan Singh’s reforms, we grew by all of 5.7 percent. In other words, by just 0.1 percent more, despite the big-bang reforms.
In the six years after that (1997-98 to 2002-03, which covers the second half of the United Front government and most of the NDA), the economy actually tapered down to an average of 5.23 percent, before finally taking off by an average of 8.45 in the next eight years.
The rebound in the economy that started in the last year of the NDA (2003-04) continued till 2010-11 – a full eight years – with a strong dip in 2008-09 during the Lehman crisis.
What this suggests is that it is the 2003-11 period that was the aberration, and not the earlier periods, when we were doing 5-6 percent after reforms. Thus we could revert to this mean if we don’t reform aggressively now. But even if we do reform, we are likely to see a growth slowdown over the next three-to-five years because reform, by definition, means the system will have to adjust to new shocks. Shocks initially bring growth down: in the year after Manmohan Singh’s reforms, India’s GDP growth in 1991-92 crashed to 1.4 percent before rebounding to 5.4 percent.
A closer look at 2003-11 tells us a more nuanced story of the eight years of growth. Did we really have that long a period of above par growth?
We did, but it was driven by steroids.
Between 2003 and 2008, the world was awash with liquidity thanks to the US Fed’s low interest rate regime and George Bush’s enormous spends on two wars. That global tide of liquidity lifted all boats, including ours.
It should have ebbed in 2008, when the Lehman crisis struck. But this is where domestic liquidity took over due to the oncoming elections. Between 2008 and now, the Indian government provided more than Rs 1,80,000 crore in terms of direct fiscal stimulus (which is still to be withdrawn fully), Rs 70,000 crore of debt writeoffs to farmers, and another several hundred thousand crore of money injections into the rural and urban economy (NREGA, higher farm support prices, heavily subsidised petro-fuels and fertilisers).
This artificial stimulation of the Indian economy is what kept growth up for three more years till 2010-11, after which it has begun to collapse. The result has been high inflation, high fiscal and current account deficits, a crowding out of private borrowers due to excessive government borrowing, and a declining rupee.
All of these point to an impending slowdown from 2012-13, and signs of this have been visible from 2011-12 itself, when growth may barely top 7 percent.
The problem is even if we do reform now, the slowdown cannot be averted, though business optimism can certainly be improved and we can sow the seeds for a revival from 2014.
Reason: almost everything we call reform will result in short-term pain. Reducing subsidies means raising the prices of petroleum products and fertilisers. Reducing the fiscal deficit means less demand for private sector products. Reducing the current account deficit means letting the rupee depreciate or enabling other forms of import compression that will also impact growth in the short run. If none of this is done, soaring inflation will bring growth down anyway.
And we are not even counting the potential impact of scams and corruption – and the impact of the Supreme Court verdicts in the 2G case, which could end up raising the costs of auctioned spectrum. The one industry that has boomed in the last decade – telecom – will now face growth blues. But if it does not face it, it will never soar again.
Ruchir Sharma, author of a new book on Breakout Nations, which speculates on which countries will continue to grow fast in the next decade, gives India only a 50 percent chance of maintaining its growth rates in future. According to him, India is more likely to become a Brazil than a China, thanks to our political class’ aggressive pursuit of welfare economics without having the growth to finance it all.
He writes: “The political elites of India and Brazil share a deep fondness for welfare-state liberalism, and both populations demand high levels of income support even though the economies do not yet generate the necessary revenue…”.
His conclusion: “If the (Indian) government continues down this path, India may meet the same fate as Brazil in the late 1970s, when excessive government spending set off hyperinflation and crowded out private investment, ending the country’s economic boom. One of the key mistakes made in Brazil was indexing public wages to inflations, which can trigger a wage-price spiral…”
This is exactly what is happening in NREGA. Not only are wages linked to inflation, the courts are now insisting that NREGA – a social safety net – must pay state minimum wages, in cases they are higher.
The reason why China has managed to register consistently high growth rates for not just five or 10 years but nearly 30 years is simple: it has regularly pushed forward with politically difficult reforms: in the late 1970s, Deng Xiaoping first allowed farmers to sell their surpluses and keep the profits. Then China cautiously opened up internal migration, then it created township and village enterprises, then it created mega export manufacturing zones on the seaboard, and then it joined the WTO – and so on. Every time growth flagged, more reforms were put on the table despite the fact that most of these reforms reduced the party’s power.
From the outside, it has seemed as if Chinese authoritarianism enabled its leaders to push difficult reforms through, but let’s not forget that every time wealth is created in new hands, it weakens the political hold of the party over the economy.
Put another way, the Chinese leadership did sacrifice some of their powers for growth.
In India, fear of losing power has pushed our rulers to move further and further away from reforms.
This is why we are going to see several leans years of growth.