FINANCIAL SCENE
The economy runs out of stimulus
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Further policy initiatives will have to wait till the new government takes office
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— PHOTO: P. V SIVAKUMAR
RATE CUTS: The Reserve Bank of India cut the short term rates last week. The move is intended to lower the cost of bank borrowing.
The announcement of the schedule for the general elections is an occasion to take stock of the macro economy. The model code of conduct rules out fresh policy initiatives or announcements. As political parties get their manifestos ready it seems quite likely that economic issues will dominate the election campaign.
Although there are other important issues — terrorism, for instance — it is the state of the economy that will be the focus, in political parties’ agenda and electioneering.
Slowdown in growth
There have been, over the past few weeks, important, if scheduled, announcements on the economy, which in their entirety give valuable insights. At the end of February, the Central Statistical Organisation came out with its estimate of GDP growth for the third quarter of the current year (2008-09). Between October and December 2008, the economy grew by 5.3 per cent, way below the 7.8 per cent recorded during the first six months. Although it was known that the economy was slowing down, the extent of deceleration probably surprised the official forecasters, including the CSO, the Reserve Bank of India and the Prime Minister’s Economic Advisory Council. All three had estimated GDP growth for the year at 7 per cent and over.
The CSO had last announced its advance estimate of growth at 7.1 per cent (for 2008-09) just three weeks before it came out with the sharply lower number for the third quarter. Even the estimates of the RBI and the Economic Advisory Council were not that far back in time: both announcements were made in January.
Estimates of growth in the last quarter (January-March 2009) will be crucial in determining whether a 7 per cent growth is feasible at all. Simple arithmetic tells us that during the current quarter the economy must grow at 7.5 per cent or so to show an above 7 per cent growth for the entire year. On present indications that seems unlikely.
However, a growth rate of between 6 and 6.5 per cent is achievable. Such a rate would be quite impressive by global standards. After all the advanced economies are shrinking and, apart from China, no other major economy of the developing world can hope to match India’s rate.
Areas of concern
Over the medium term, however, the third quarter deceleration to 5.3 per cent is the strongest indication yet that the days of high growth — of nearly 9 per cent each year — have ended at least for now. There are far too many factors at work, global and domestic, that will keep the economy down.
Two areas of serious concern are worth noting: the unsustainable fiscal situation and falling exports. Both are linked to the global economic crisis.
The government’s inability to spend much more than it did in each of the three stimulus packages to reverse the rapid slowdown in the domestic economy is well documented. Governments around the world needed to come out with such stimulus packages to boost demand, whose shrinkage is a cause as well as a manifestation of the global economic crisis. The deteriorating export performance is also attributed to the collapse of demand in the importing countries. For whatever reason, India may claim to have escaped the full brunt of the economic crisis, but there is no doubt that it will remain affected for a long time to come.
It will be a dire fiscal situation that the new government will inherit in June. After the latest (and because of the elections, the last for now) stimulus package the Central government’s fiscal deficit could be close to 9 per cent of the GDP by the end of the current year after taking into account the off-budget liabilities. Along with the States, the consolidated fiscal deficit could be close to 12 per cent of the GDP, an all time high for the country.
As has been the case with most other countries, urgent monetary and fiscal measures are being taken to revive the economy. The interim budget stayed clear of significant stimulus measures, concentrating its spending proposals on the UPA government’s flagship social sector schemes.
Barely a week later, however, the Government announced cuts in excise duties and service tax. The package is estimated to cost over Rs. 29,000 crore which will push the fiscal deficit higher.
Fresh cut in rates
On Wednesday, the RBI cut its repo and reverses rates by 0.50 percentage point. The move is clearly intended to lower the cost of bank borrowing. However, a combination of factors might make the objective difficult to achieve. Banks’ reluctance to lend during times of economic uncertainty is well known. Also, the large government borrowing programme will put pressure on interest rates. But fiscal policy does not have any headroom. Even if it has, the government cannot announce major initiatives or expenditure plans until the elections are over and a new government takes office.
Balance of payments
The other big challenge for the new government is going to be on the external account. The larger issue here is to shore up the balance of payments at a time capital flows have reversed and when both invisible earnings (software exports and income from other services) and remittances from overseas Indians have come under pressure.
The sharp fall in overseas trade comprising both exports and imports in January 2009 is a cause for worry. A fall in imports is due to low domestic demand.
For the fourth consecutive month since October exports have dipped, by 16 per cent to $12.38 billion in January 2009 while imports contracted by 18.2 per cent to $18.45 billion in that month.
The stock markets dropped to their lowest levels in three years last week. The rupee went below 52 to the dollar before recovering marginally. On the eve of elections there is not much good news for the Indian economy. The saving grace is the situation is not as bad as it is in many other countries.
C. R. L. NARASIMHAN
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