Primary concern is to control inflation'

Interview with C. Rangarajan, Chairman of the Prime Minister's Economic Advisory Council.

AS India's economic growth is in slowdown mode, the authorities are putting on a brave face on what in their view is a transitory phenomenon. In order to get a proper understanding of the underlying weaknesses in the economy and their fallout in terms of the prevalent pessimism, Frontline spoke to Dr C. Rangarajan, the ace economist and Chairman of the Prime Minister's Economic Advisory Council (PMEAC), at his Vigyan Bhawan Annex office in New Delhi. Known for demystifying jargons to make even complex issues easy to understand, Rangarajan is sanguine about the prospects of the economy, both in the short term and over the long haul. Excerpts from an interview with him:

What is your forecast on the gross domestic product (GDP) growth for the current fiscal, given the distinct slowdown of the economy?

It is my estimate that the Indian economy will grow between 7 and 7.25 per cent. We have lowered the growth estimate from the earlier level of 8.2 per cent. The factors responsible for the decline in growth rate are many. One, the external factors have not been very hospitable for a faster growth of the economy. In the current fiscal, agriculture will do well as the monsoon has been good, and farmers are expected to take advantage of it. The services sector is also growing at a reasonably high level. It is only with respect to industrial production one notes a slackening in growth. The reasons for the decline in the industrial growth rate can be traced to tighter monetary policy, rise in inflation and weak sentiments in the markets.

The fixed capital investment has come down from the pre-crisis levels of 33 per cent of GDP. Some of the areas in which decline in production has been noted include coal and electricity. Coal production has declined for three months in a row, but there was some improvement in November. But the decline in the output of some of the infrastructure areas has affected overall growth.

To some extent the rise in interest rates may also have affected the incentive to reinvest. It might have led to the postponement of investment in the hope that the interest rates will come down later. To this must be added the sentiments within the corporate sector which might have been affected by a variety of factors that happened in the last one or two years in the polity.

Now, what can be done in order to reverse the trend that has been seen? First, investment-output targets set for the various public enterprises must be fulfilled. There has been a shortfall in meeting coal output. Capacity creation in electricity has fallen short of the target. Hence, a strong growth in public investment can be the driving force for the revival of sentiment and for pushing the economy forward.

Are you suggesting another bout of fiscal stimulus after the ones we have had since 2008?

No, the fiscal space available now for any stimulus has narrowed since 2008. A fiscal stimulus is not possible, but the fulfilment of the targets set for the various entities in the public sector in the areas of road, railways, ports and electricity can act as a big force for reviving the economy.

Second, as inflation is coming down, there can be a reversal in the stance of monetary policy as well.

Is the trade-off between fighting inflation and promoting growth telling upon itself in the slowdown?

People talk of trade-off between inflation and growth but this is not a genuine trade-off. A low level of inflation is most conducive to economic growth in the medium-term. One should therefore look at the efforts to tame inflation as a move to maintain the appropriate environment for medium-term growth. Therefore, to some extent, the tightening of monetary policy may have had some effect on the growth of the economy in the short-term. Investors might postpone taking on new projects in the hope that the interest rate will come down later.

Nevertheless, taking action to control inflation has become increasingly important because inflation rates had touched very high levels. Since January of this year until November the inflation rate has remained above 9 per cent. The primary concern of the monetary authority is to control inflation.

But there are signs of inflation coming down. Food inflation showed a sharp decline in the first week of December. Unlike last year, when food prices, including vegetable prices, rose sharply during winter, this may not happen in the current year. Therefore in the first quarter of the calendar year 2012, we will see a very sharp decline in food prices. I expect that by March 2012 the inflation rate will go down to 7 per cent or even below that.

Is there any worry over the soundness of the country's banking industry as the overseas rating agencies had questioned their asset quality in recent times?

The non-performing assets (NPAs) as a proportion of total advances have shown some increases in the recent period. Nevertheless it remains at a low level. The borrowing programmes of the government have been enhanced slightly, but this is partly because the collections from small savings have come down. Therefore it is really a compensatory effort. On the whole, the demands on the banking system by the government will not be much higher than what was originally envisaged. The banking industry needs to watch its lending programmes so that the NPA as a proportion of total advances is kept at the current level.

Well, when rating agencies talk about asset quality, they talk in terms of lending by the commercial banks to priority sectors. In one sense, when the economy is not growing fast, there is always a tendency for the NPAs to rise because the investments had been made on certain expectations of growth and if growth comes down below the expected level, there is always some problem. But if growth picks up, this problem will be resolved. Therefore I think the problem being faced by the banking industry may be temporary in nature. Once growth picks up, this problem should go. I do expect that in the next fiscal 2012-13, the economy will grow closer to 8 per cent.

What is your view on the rapid depreciation in the exchange value of the rupee and the sustainability of the current account deficit?

The current account deficit in the current year may be higher than 2.5 per cent of GDP, which we had indicated in our last report. But the problem on the rupee has developed because of a mismatch between the current account deficit and capital flows which are required to finance the deficit. Last year our current account deficit was 2.6 per cent of GDP, but the capital flows were adequate to cover the current account deficit and to add $15 billion to the reserves.

In the current fiscal, the capital flows have not been adequate and consequently the pressure on the rupee has developed. If capital flows revive in the course of the first three months of 2012, the pressure on the rupee will ease.

Are policy inertia and reversal of reform such as opening up multi-brand retail to FDI responsible for investors' reluctance to bet on India with their money?

Capital flows are dependent factors that operate in the rest of the world. Capital flows diminish towards the end of the year. December is not a month when one finds large capital flows. Since most of the companies work on the basis of the calendar year, the allocations to India will pick up in the first quarter of calendar year 2012 and that is the reason why I expect the capital flows to improve after the onset of 2012. No doubt, investors are influenced both by external and domestic factors. To the extent to which growth has been below expectations, it will affect the sentiments of foreign investors. The high level of inflation and decline in industrial output might have had some effect upon the investors' attitude. As India still maintains a high growth of over 7 per cent, India may still rank high when foreign investors are allocating funds among different countries.

Are the rights-based approaches to development by the United Progressive Alliance (UPA) and mounting subsidies out of sync with fiscal health?

I think it has to be managed. Obviously, if the food security Bill covers a much larger segment of the population, the subsidy will go up. What is therefore really required is prioritising the subsidies one might give more subsidies under food security but some other subsidies have to be adjusted downwards in order to accommodate that. Therefore what is really relevant is the total amount of subsidy provided in the Budget. Perhaps we are now providing large subsidies for petroleum products and fertilizers. If the subsidy to support food security goes up, we must be willing to make necessary downward adjustment in petroleum and fertilizer subsidies.