All the signs are that India has entered a new phase of low growth – what we should call the Nehruvian natural state of 3-5 percent annual growth, which was wrongly dubbed the 'Hindu rate of growth'.
Before we talk about these signs, it is worth asserting that a slowdown is the only thing that will help correct the gross economic distortions introduced by the UPA during its economically-damaging second term in office – which, of course, was the logical consequence of its roller-coaster ride in the first term where it abjured all reforms.
The distortions are the following:
One, there’s been a huge bloat in energy subsidies – in oil, gas, coal and power – which are essentially subsidies for the relatively rich or for business. Yesterday’s decision to double gas prices to $8.4 per mmBtu from 1 April 2014, and the earlier decision to keep raising diesel prices by 50 paise every month are tacit acknowledgements of this.
Two, the country is living wildly beyond its means – both internally and externally. The fiscal deficit – the difference between what the government earns and its proposed expenses before borrowings – is well over 5 percent if one includes oil subsidies that haven’t been budgeted for. In 2007-08, the deficit was Rs 1,26,912 crore; this year, even after P Chidambaram’s so-called austerity measures, the figure is more than four times higher at Rs 5,42,499 crore.
Worse, as the Reserve Bank’s figures released yesterday show, the country is deeply in debt to the world outside. The country has $261 billion in foreign exchange reserves (excluding gold); it has $390 billion in debt (as on 31 March 2013), and rising. If the world wanted its money back today, the country wouldn't be able to return more than two dollars for every three dollars owed. And remember, nearly 60 percent of our debt has to be paid off over the next year. Is it any wonder the rupee is falling?
Three, the country has prematurely tried to create a welfare state even before it has had adequate opportunity to drive growth, and build state resources. From NREGA to loan waivers, Food Security to Land Acquisition, the Sonia Gandhi-led dispensation has poured money into wasteful schemes in a foolish bid to buy votes and stay in power. In the process, the government has also raised costs for all businesses. In an election year, it is unlikely that this government – any government – will have the guts to change course.
It is these politico-economic issues that make the India story unviable in the short-term. The immediate cause for the crash of the rupee is, of course, external, as the world is adjusting to the possibility of US Fed Chairman Ben Bernanke reducing his bond purchases, but the fundamental economic distortions are self-created by the UPA.
The India growth story is turning cold both because of past excesses and because corrective action will cause more pain in the short and medium term.
Now, for the signs of an economy that's tapering down.
1. The drastic fall in the CAD for January-March period to 3.6 percent from 6.7 percent in the previous quarter is a signal not of a correcting CAD, but a slowing economy. The same is the case with inflation, which is falling not because of a better demand-supply balance, but declining growth. This is why the wholesale price index is at half the level of consumer prices, indicating that industry is unable to pass price increases through.
2. The doubling of gas prices and the steady increases in diesel are intended to raise domestic production and reduce imports. But the short-term impact of these price hikes will be inflationary - as gas costs feed through to fertiliser and power industries, and a falling rupee makes all energy costs higher. This will ensure that the slowdown will be with us not just this year, but also the next.
3. Food inflation is set to remain high, if not soar again. The prime reason for this will be the Food Security Bill. The FSB has two negative impacts: one is to raise the subsidy bill - which is inherently inflationary because higher food subsidies means higher procurement, which means higher support prices, which means higher storage, movement and fertiliser costs. The second negative is the obverse side of selling grains at Re 1, Rs 2 and Rs 3 a kg to the poor. The poor will buy the cheap grain and sell a part of it in the open market which will then be used for higher-protein food (milk, veggies, meat, eggs, etc). Recent food inflation has been caused not by rice or wheat, but protein items. The FSB will thus directly make food inflation worse. Nothing slows down an economy more than inflation.
4. The rupee's depreciation will slow down all economic activities as imports are squeezed and borrowers in dollars squeeze budgets to pay back loans and invest less. In the near future, companies will prefer to hoard cash rather than invest since the economic climate will be uncertain. This will worsen the slowdown , given what we need to revive growth is more investment.
5. In June, foreign investors sold Rs 40,000 crore worth of debt and equity, indicating that they too think returns after adjusting for country and exchange risks will be better outside India. Without a market revival there is no chance that Indian companies themselves will invest.
In short, India's growth story is back to the low-equilibrium levels of the Nehruvian era. The only antidote to it is very strong reforms in energy pricing, FDI, labour and land markets. Large chunks of the public sector need to be sold off - and not just divested piecemeal. Or else we should cut welfare spending drastically.
The UPA has killed the India story and its current actions do not suggest any reversal of this trend. For the next three years, I see growth in the range of 4-5 percent.
And a cut in welfare spending.