In a low-growth trap

Print edition : June 06, 1998
C.P. CHANDRASEKHAR

THE central message from the evidence presented in Economic Survey 1997-98 is one that the Government has chosen not to emphasise. India's post-reform economic boom has petered out, having lasted for just three years, until 1995-96. The loss of momentum was first reflected in a deceleration in industrial growth in 1996-97. In the subsequent year (1997-98), not only did the recession in industry intensify, but growth slowed in the agricultural sector. Ignoring this trend of decline, the Economic Survey focusses on the poor performance in 1997-98 alone.

According to advance estimates made by the Central Statistical Organisation (CSO), gross domestic product (GDP) grew by just 5 per cent in 1997-98 as compared with 7.5 per cent in 1996-97. In fact, each of the three years ending 1996-97 had witnessed GDP growth rates exceeding 7 per cent, with the average rate of growth during those years amounting to 7.5 per cent. Thus the growth slowdown is seen as having occurred only in the last financial year, "mainly" because of a 2 per cent decline in the contribution of agriculture as compared with a 7.9 per cent rate of growth in 1996-97 and partly because of a deceleration in manufacturing growth to 6.1 per cent in 1997-98 as against 7.4 per cent in 1996-97.

However, focussing attention on industry rather than agriculture would have revealed what appears to be a more fundamental tendency. The CSO's Index of Industrial Production points to a reversal of the post-reform boom since 1996-97. Until that year, industrial growth showed a remarkable recovery in the post-reform period, having risen from 0.6 per cent in 1991-92 to 2.3 per cent in 1992-93, 6 per cent in 1993-94, 9.3 per cent in 1994-95 and 12.1 per cent in 1995-96. This trend had made industrial performance the most visible sign of the success of economic reform. However, industrial growth fell to 7.1 per cent in 1996-97 and has declined further to a poor 4.6 per cent in 1997-98. The deceleration is even sharper (from 13.7 per cent to 9.3 and 4.2 per cent) when the index for the manufacturing sub-sector is taken into account. Thus, the recession that set in in 1996-97 and persists even now suggests that the reforms have failed to deliver after an initial spurt.

The persistence of the recession is even more grave when seen in the light of the facts that: 1. It began in a year (1996-97) when agricultural production registered a remarkable increase because of the good monsoon; and 2. It persists despite the fact that there has been no significant cutback in government expenditures in 1997-98, when the fiscal deficit rose to 6.1 per cent of GDP.

That is, both agricultural performance and government expenditure, the two oft-quoted influences on industrial performance, should have contributed to a degree of buoyancy in industry. If instead we are faced with a recession, it must be because other factors accounted for the post-liberalisation boom. It is now widely acknowledged that the high rates of industrial growth during the years 1993-94 to 1995-96 were largely the result of a spurt in production of import-intensive durables which catered to the pent-up demand for such goods released in the wake of liberalisation of trade and investment rules. With that once-for-all market having been exhausted, growth has come to depend on the expansion of the home market. With the unequal distribution of assets and incomes limiting the rate of autonomous expansion of the market for mass consumption goods, the growth of the home market becomes dependent on the direct and indirect demand-generating effects of State expenditure.

This means that if the Government has to try and "kick-start" the economy, to use the Finance Minister's terminology, the fiscal stimulus would have to be much larger than was provided in 1997-98.

UNFORTUNATELY for the BJP-led coalition Government, the recession-induced pressure for a larger fiscal stimulus becomes effective at a point of time when the huge tax concessions provided by former Finance Minister P. Chidambaram have substantially reduced the revenue-raising ability of the Government.

Increasing expenditures at the existing rates of taxation would result in a rise in the fiscal deficit. On the other hand, raising tax rates, especially direct tax rates, could adversely affect domestic and foreign investor sentiment; it may also be seen as a reversal of one of the central features of the agenda of reform. Whatever combination of expenditures, tax rates and the fiscal deficit is chosen, the threat of hurting investor sentiment either through raising taxes or increasing the size of the fiscal deficit would substantially constrain the ability of the Government to spur a recovery.

The other option before the Government is to hike customs duties on manufactures so as to finance higher expenditures as well as increase protection for domestic industry. Together these effects of an across-the-board customs duty hike could help spur industrial growth without taking the fiscal deficit to unusually high levels. However, even more than in the case of higher direct taxes, higher customs duties would involve a retreat from the path of trade liberalisation pursued under previous governments. Opting for it could, therefore, trigger a loss of investor confidence, which by affecting dollar flow at the margin can result in a collapse of the rupee.

Thus, most fiscal measures aimed to stimulate a recovery can trigger uncertainty in a market attuned to governments relentlessly pursuing reform. This "uncertainty factor" is all the more compelling given the instability in the capital and foreign exchange markets created by the nuclear tests and the sanctions that followed. Preliminary indications are that the Government is in a conciliatory mood, willing to offer economic concessions to international investors in return for a degree of moderation by developed countries in response to India's nuclear weaponisation.

As the Economic Survey puts it in a hastily added postscript to its "General Review": "To the extent to which these reactions (to the nuclear tests) render the external environment less friendly, to that extent, it becomes more urgent to implement the policy decisions necessary to encourage macroeconomic stability and rapid and sustainable economic growth." This could encourage the Government to abjure hard budgetary measures and rely on resources mobilised through privatisation of public assets or through the launch of a Mark II version of the Voluntary Disclosure of Income Scheme (VDIS). However, it is unlikely that this would yield resources of a kind that improves the Government's room for manoeuvre substantially.

To sum up, it appears that a Government inclined to push ahead with liberalisation is caught in the midst of a low-growth trap. In the shoddily written Macroeconomic Overview, Finance Ministry mandarins strive verbally to wriggle out of this trap.

ATTRIBUTING the growth slowdown to a combination of supply bottlenecks (in the form of "the quantity, quality and cost of basic infrastructure services") and "temporary demand factors" (in the form of an externally influenced cyclical deceleration in exports and inadequate credit access due to tight money conditions in 1995-96!), they desperately grasp at ostensible signs of a recovery in the form of "the sharp rise in sanctions and disbursements of All India Financial Institutions and the rise in stock market prices during March and April 1998."

But such poorly handled verbal jugglery can hardly help a Government caught in a bind. In fact, as the Survey figures indicate, the current low growth situation is particularly disconcerting because it has been accompanied by a sharp rise in the trade deficit in the balance of payments from $2.3 billion in 1994-95 to $5.7 billion in 1996-97 and $6.8 billion in 1997-98. Initially the rise in the trade deficit was due to a sharp deceleration in the growth of the dollar value of exports.

According to DGCI&S (Directorate-General of Commercial Intelligence and Statistics) data, the dollar value of exports which grew between 18.4 and 20.7 per cent per annum during 1993-94 to 1995-96, decelerated sharply to 5.3 per cent in 1996-97 and 2.6 per cent in 1997-98. Import growth also fell from 22.9 per cent in 1994-95 and 28 per cent in 1995-96 to 6.7 per cent in 1996-97 and 5.8 per cent in 1997-98. However, since the deceleration in export growth was far sharper, the trade deficit tended to widen.

But the composition of recent import growth is of interest. In 1996-97, according to Balance of Payments data, POL (petroleum oil and lubricants) imports grew by 33.4 per cent whereas overall import growth stood at 10.1 per cent. That is, the deceleration in import growth was largely due to a deceleration in the growth of non-oil imports (from 32 per cent to 5.2 per cent) which was attributed to the industrial recession. In 1997-98 however, DGCI&S data indicate that the fall in international oil prices resulted in 20.6 per cent decline in the dollar value of oil imports. If, yet, overall imports grew by 5.8 per cent, it was because of a sharp increase of 14.5 per cent in the dollar value of imports. That is, despite the persisting recession, non-oil imports have been rising in recent times. This would mean that if by, say, pump-priming the system, the Government seeks to raise industrial growth, the import bill could register a runaway increase resulting in a sharp increase in the trade deficit. The problem would be compounded by any reversal in the recent decline in international oil prices. As a result of these developments, despite buoyant remittance flows, the current account deficit which stands at 1.5 per cent of GDP (as compared with an average of 1.1 per cent over the period 1991-92 to 1996-97) could rise even further. This would undermine investor confidence and trigger a run on the rupee.

This confluence of tendencies that put pressure on the rupee is of significance because the massive depreciations of the currencies of India's East Asian competitors is pushing a Government faced with a deceleration in exports to adopt a strategy of letting the rupee slide. The danger, of course, is that, as happened in some South-East Asian countries, there is every possibility that the slide would soon convert itself into currency collapse which the Reserve Bank of India may find difficult to halt.

Not surprisingly, the Survey argues: "One of the continuing challenges of exchange rate management in emerging markets is the balance between the two objectives of responsiveness to market fundamentals and the need to dampen volatility." Unfortunately, here, as elsewhere, the recognition of a problem is not accompanied by any serious effort at discussing alternative solutions to the problem at hand. This lack of perspective is disastrous especially because policies elsewhere, such as the nuclear weaponisation programme, only worsen capital and currency market volatility, making the task of dealing with fundamentals and restoring growth near impossible.

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