Why new normal under Sonianomics may be 4-5% GDP growth

Just when you thought the bad news was coming to an end, there's more. The mere flash of a missile attack on Syria was enough to send both the rupee and the Sensex packing. On Tuesday (3 September 2013), the rupee breached Rs 68 to the dollar again and the market index was at one stage down more than 700 points.

Markets will, of course, be markets, but there is no reason to think that this mood is transient. The mornings papers, for example, show a sharp fall in business confidence, with the purchasing managers index (PMI) falling to 48.5 (anything below 50 is a contractionary signal). And economists were busy knocking the bottom out of GDP estimates - Bank of America Merrill Lynch has cut GDP estimate for 2013-14 to 5.5 percent from 5.8 percent, but this looks like the upper limit of optimism.

 Why new normal under Sonianomics may be 4-5% GDP growth


The consensus is now moving towards 3.7-4.2 percent, with BNP Paribas being the most pessimistic, and Nomura and CLSA relatively more optimistic at 4.2 percent. HSBC is at 4 percent.

If there are now more prophets of doom right now, the reason is clear. As this writer had indicated several months ago (read here), India, with a penchant for scoring self-goals, is heading for a period of low growth. The fact that global panic is aiding the negative sentiment cannot blur the fact that this is our own mess, created by ourselves.

In June, we wrote: "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'." Since the current slowdown has been brought about by Sonianomics, we should name the new normal after her: 4-5 percent, the Sonia Rate of Growth.

I reproduce below the bulk of that article, with a few modifications to correct for recent developments. The point, though, is that it is best for us to accept the slowdown for real - and it will be with us for a while.

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. In oil alone, the UPA's subsidies are heading for a total of over Rs 7,50,000 crore over 10 years.

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 in June show, the country is deeply in debt to the world outside. The country has $250 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, as recent capital outflows seem to suggest, 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 pork-barrel and ill-thought-out schemes in a 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.

How will P Chidambaram balance the economy given the welfare spending plans? 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 - slowly, but temporarily - not because of a better demand-supply balance, but declining growth. This is why the wholesale price index is far lower than consumer prices, indicating that industry is unable to pass price increases through.

2. The proposal to raise diesel after this parliament session and gas prices from 1 April 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 the year to date, foreign investors have sold over Rs 30,000 crore worth of Indian debt, and in August, they have sold a billion dollars worth of shares as well (Rs 6,200 crore, to be exact). Clearly, 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. But we can be sure that won't happen, for Sonia Gandhi has pushed the Food and Land Bills even in the face of an economic downturn. 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.

India is in a downward spiral, and it will need a change in government and early elections.

Updated Date: Dec 20, 2014 23:51:42 IST