Can India beat this slowdown?

  • Blog Post Date 24 February, 2016
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Jayan Jose Thomas

Indian Institute of Technology, New Delhi

RBI Governor Raghuram Rajan has cautioned the government against seeking to generate economic growth by increasing public spending and hence, adding to the fiscal deficit. In this article, Jayan Jose Thomas, Associate Professor of Economics at Indian Institute of Technology, Delhi, puts forth the view that the only engine that can pull the Indian economy forward at the moment is government expenditure.

The world economy is so hard to predict. In 2008, as the global financial markets plunged into a crisis, high oil prices were considered to be one of the factors that caused it. Today, many fear that the world economy is on the edge of another recession. Guess what is high up there on the list of its contributing reasons: low oil prices.

The price of crude oil remained mostly above US$100 per barrel for almost three years from 2011 onwards, but declined sharply during the second half of 2014, settling at around US$50 per barrel for a good part of 2015. Stock market prices collapsed in many parts of the world in January this year when oil prices fell to even greater depths, touching below US$30.

One of the reasons for declining oil prices is the advance made over the last few years with respect to oil production, especially in the US. The recent lifting of sanctions against Iran has eased the supply situation even further. But the falling oil prices are also a reflection of the stagnation in worldwide demand, and this is what has made the stock markets panicky.

China"s economy is projected to grow at 6.3% in 2016, its slowest growth in 25 years. A slowing China has far less appetite for oil and other commodities. This has adversely affected a number of emerging economies, which are suppliers of commodities or are closely linked to the Chinese production networks. Russia and Brazil, both major commodity-exporters, registered negative rates of growth of gross domestic product (GDP) in 2015.

The good news, and the bad news

Amid all such mayhem, India’s economy appears to stand tall. Its projected growth for 2015-16, at 7.3%, makes it the fastest-growing large economy in the world, according to the International Monetary Fund (IMF). India is a large importer of oil, and therefore falling oil prices have been beneficial to its economic growth. India’s oil imports as a proportion of its GDP have come down from around 9% during 2011-14 to less than 5% now. With the fall in oil prices, inflation based on the wholesale price index (WPI) has been in the negative territory in the country since November 2014.

However, the picture of growth and stability presented by the above-quoted figures is misleading. To begin with, it is important to note that scholars have raised questions on the recent GDP growth figures, which are based on a new methodology employed by the country’s statistical agencies in estimating national income.

More important are the wide variations in growth across sectors. Monsoons have been deficient in the country for the second consecutive year, with a disastrous impact on agricultural production and rural demand. The performance of the manufacturing sector has been unimpressive. Micro-and small-industrial units in particular have been facing a crisis over the last several years. Year-on-year growth of India’s exports has been negative for 12 consecutive months. There has been a surge in manufactured imports into India in recent years. Imports from China have increased markedly following the slowdown in that country’s economy. It is only due to the high rates of growth in the services sector that India’s overall economic growth appears robust.

Given its nature as described above, it is not surprising that India’s economic growth has had a poor record with respect to employment generation. I have made certain estimates on employment growth in India between 2004-05 and 2011-12, a period of exceptionally fast economic growth for the country. They show that, given the growth in the working-age population, the workforce engaged in industry and services in India could have potentially increased at the rate of 15 million a year during those years. But the actual increase that occurred was at a far slower rate: only around seven million jobs annually.

Government as a demand-driver

The growth of aggregate demand in an economy is derived from four sources: private consumption, private investment, government expenditure and net exports. The boom years of the Indian economy were between 2003-04 and 2010-11, when its GDP grew at an average annual rate of over 8%. Private investment and exports were important drivers of growth during the first part of this high-growth phase, which lasted until 2007-08. But export growth nosedived in 2008, and has never really gained momentum ever since, with the global economy moving from one crisis to another. Despite this, India’s fast growth continued, thanks to the stimulus measures launched by the authorities, which led to an impressive pickup in consumer demand, especially for automobiles and housing.

However, India’s domestic private investors have got cold feet since 2011-12. The reasons for this include the sagging demand conditions at home and abroad, and the unutilised capacities they had built during the previous years. Many of them are also heavily indebted.

Private consumption expenditure accounts for the largest share of aggregate demand in India. But it cannot be an independent driver of growth for the economy. Further, consumer demand in India is not mass-based — with bulk of the expenditures coming from a small category of the rich — and therefore not beneficial for industries that want to gain from economies of scale.

In the current circumstances, it seems that the only engine of demand that can pull the Indian economy forward is government expenditure. No one disputes that India has huge investment needs in irrigation, electricity, rural and urban infrastructure, as well as in many areas of basic research. But these are all long-gestation projects, offering little immediate gains to any investor. Naturally, private investors have been wary about putting their money in them. These are precisely the areas where the government should step in, raising public investments to remove some of the long-standing constraints to growth and development.

The advantages offered by low oil prices by reducing inflation and external payments create an opportune environment for India to increase public investment in the country. In fact, the Finance Ministry’s Mid-Year Review released in December 2015 stresses on the need to raise public expenditures in India in the current context. At the same time, many voices within the policy establishment and outside have warned against any rise in public expenditures that may result in fiscal deficits above certain targeted levels.

Governments in India and elsewhere commit themselves to maintaining fiscal-deficit targets largely because they fear that not doing so would scare away foreign investors and anger global finance. It is perhaps important for them to recognise that they are undermining themselves by bowing too much to the dictates of global finance — this unkind monster that has stoked economic collapses time and again.

The world economy is likely to see more turbulent days ahead. If foreign investors and foreign markets are going to be staggered in these uncertain times, India will have little to gain by going after them. Instead, the country’s policymakers should turn their attention inward, devising strategies to unleash domestic markets and entrepreneurship in this large and diverse nation.

This article first appeared in The Hindu on 17 February 2016.

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