India's jugaad economy keeps chugging along - somehow

One fact echoed by economists is that in Globo-crisis 2.0, now underway, India is still the second fastest growing economy in the world after China. Yet, we at home are not happy and remain critical of inflation, monetary policy, fiscal policy, reforms and so on.

We can debate whether growth this year will be 7 percent or 8 percent, but the fact is it does not matter. It will still be high and our global ranking will not change. Even China has had a setback with growth slipping to single-digits and the inflation bug biting them, too.

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It appears that we are - to use some domestic lingo - a jugaad economy. Things just seem to happen, finally. Let us see the images that are present on the eve of the Reserve Bank of India’s mid-year review of the economy, where there will be different perspectives flashed.

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The positives are many. First, the monsoon has been good for the second successive year, which means that farm output should be on course. There are some lower projections for pulses, coarse cereals and groundnuts, but, on the whole, the kharif numbers should be good. Growth of 3-4 percent looks highly likely.

Second, while industrial growth so far has not been impressive, given that we have pursued anti-growth policies and scaled down our expectations to 7 percent for the year, the number of 5.6 percent so far during the so-called slack season is impressive. This is despite the successive interest rates hikes unleashed by the Reserve Bank of India (RBI).

Also corporate sales have been buoyant in the first quarter of 2011-12, and the early results in the second quarter don’t look bad at all. Things do appear to get better as we move into the festival season as consumer spending is reignited.

Third, despite the global slowdown with all kinds of doomsday prophecies, our exports have grown by 52 percent during the first half of the year. Considering that this comes over a high base last year, it is even more remarkable.

Fourth, foreign direct investment (FDI) inflows continue to be impressive, thus dispelling the notion that the global crisis affects the flow of funds. We have had $17.4 billion coming in in the first five months, which is double that of $8.8 billion during the same period of last year. The India story surely still shines. Add to this the fact that our forex reserves have increased by around $7 bn to $ 312 billion and the picture is really not that bad.

What then are the ‘buts’, or qualifications, to this steady performance? This is the darker side of the growth story that we have witnessed in the last two years.

First is inflation, which remains close to 10 percent. This is irksome not just because it is high, but also because no one quite knows what has to be done to bring it down. Food inflation is a puzzle because, despite all-time high foodgrains production, prices are soaring, and the culprits have been horticulture, milk and poultry products.

People have tried pointing fingers at various causes - NREGA spending contributing to excess demand, vegetable production failures, or global factors or minimum support prices - but the fact is that there does not seem to be any cure. This is unsettling because one does not know what to expect.

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Second, the fiscal deficit has become a cause for concern. The absolute ratio actually does not matter whether it is 4.6 percent or 5.1 percent or 5.6 percent. The issue is that the government could cut back on project expenditure at a time when investment demand is down to restore the fiscal balance by spending less.

And this is dangerous because the government is the only entity which still borrows funds at rates that are lower than the base rate of banks - and this could go up to a maximum of 9 percent! This is the concern, rather than the liquidity drag caused by higher government borrowing of Rs 53,000 crore planned for the year.

Third, private investment has slowed down. This is a problem because when there is an upswing in activity it will take time to build capacity, which will slow down the recovery process. The reason is increasing interest rates. While interest costs account for 2-3 percent of turnover in the manufacturing sector, it matters more for infrastructure projects, where loans have to be serviced at this rate for the life of the project. Therefore, a double dip slowdown is possible in a worse case scenario.

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Fourth, due to all the noise about governance issues, there has been a diversion of government time from reforms - which are needed for propelling the economy in future. Insurance, pension, retail, commodity market reforms and taxation have receded to the background on this account. This again may not come in the immediate way of growth, but certainly affects future prospects.

Fifth, the current account deficit has started widening. This, combined with the growing external debt on account of short term debt, poses problems for the balance of payments.

How does one evaluate the economy ‘on balance’?It actually appears to be well on course in difficult times and the issue of the twin deficits (fiscal and current account) is a prime concerns for all countries. They are not germane only to us.

Inflation is a tough one, and the RBI’s response will be interesting. If the rate hikes have not worked in the last 18 months, will they work now? But, if we look at this differently, the rate hikes have lowered growth in credit and industry, which is what was intended. So, this can mean that for the last leg of the monetary policy to work out - that is, impact inflation - there is scope to increase rates further. So another hike may be justified.

What about growth? Well, notwithstanding all the odds, the jugaad economy will chug on and growth of 7.5-8 percent will be a good number. We like to talk a lot of organised industry and its travails and concerns. We get concerned over policies. But, somewhere behind the scenes, there is the farm sector and the services sector, apart from the small sector. Lots of things are happening and bringing about this growth. This is encouraging.

Madan Sabnavis is Chief Economist, Care Ratings. The views are personal.