Pragmatic approach, DNA , January 18, 2010

There is a feeling of economic euphoria in the country today with even economists talking of 8 per cent growth in GDP, double digit industrial growth rate, soaring Sensex, and a revival in exports. The gushing in of foreign investment has added to this optimism. Inflation surely is spoiling the party but then after a point it is beyond our control when there is crop failure.Against this backdrop, there is talk about whether the government is going to pursue an exit policy. What exactly are we talking of?It may be recollected that when there was an economic slump in the last quarter of 2008 following Lehman, the entire world went into a stimulus mode. What governments essentially did was to pump-prime their economies.Central banks lowered interest rates while the Fed and US Treasury provided capital and guarantees to various financial institutions to restore confidence.Governments went soft on their deficits and began cutting tax rates and increasing their spending so that their economies were on their feet. They supported financial institutions through recapitalisation and direct funding measures. In fact, UK, USA, Japan and the Euro zone all have fiscal deficit ratios that are higher than that of India. The basic idea was to eschew the possibility of a full-scale recession as was the case in 1930 when the Depression ostensibly was aggrandised because governments did nothing.
Therefore, the booster shots were all encompassing. The significance of this approach is that it was pursued by all leading economies almost in cohesion; and more importantly they worked. Almost all countries are showing positive growth, and have come out of the low phase and are seriously thinking about rolling back some of these measures.For us in India, it is necessary to debate this issue because we have two critical policies coming up — the RBI credit policy towards the end of January and the Budget towards the end of February. While the first will give us an idea of the official view of the state of affairs, the second will provide a definite direction. So, we can see these two statements actually putting in perspective the confidence that we have in our economy. Now, the high growth witnessed in the country has come mainly from the services sector, where the social and community services segment, which means the government, has played a critical part. The sharp duty cuts reckoned in 2008 have also helped to stabilise industry which is displaying a steady growth rate for the period September-November 2009.A reduction in such expenditure would be justified provided we are sure that the other sectors would be able to provide the necessary bulk to keep the economy on the upswing.For the current financial year, agriculture has been a failure and a negative growth rate is expected, which means that unless we are sure of this growth in future, any withdrawal of the fiscal stimulus would affect overall growth.Or there has to be compensation from some other sector. Assuming high industrial growth this year of say 8-9 per cent, sustaining the same over a high base could be a challenge.As far as tax rates go, while we have accepted a Goods and Services Tax (GST), its implementation is still a distance away and presently we will have to toss whether or not we go back to the pre-2008 duty structure. While industrial growth has been steady, are we prepared to disturb the applecart at this stage? Probably not, because industrial growth has been supported substantially by fiscal action in the last nine months or so and it may be prudent to persevere with the same until we are certain the growth is self sustaining. Industries like capital goods, cement, construction, intermediates and so on have definitely benefited from such action. A roll-backtoday could be counter-productive. How about inflation? Inflation is a grave concern here and should provoke affirmative action from the RBI on January 29. The value of growth is eroded substantially when inflation, especially food inflation is of the order of 15 per cent or so. This has been caused by compression in supplies on the agriculture side and rising demand as evidenced by rapid growth in industry, which has pushed up prices. In fact, if we believe the high growth story, which most do, then there is reason to curb the demand forces and hence tighten the belt. Also it is said that monetary policy has to be forward looking as central banks have to target potential inflation rather than current inflation.There is hence strong economic rationale for monetary action to control inflation while keeping the fiscal window still open for some more time. We should hopefully be within the 6.8 per cent fiscal deficit targeted for this year and there is no hurry to improve on it presently until growth stabilises. Monetary tightening is certainly needed more through rate hikes than reserves pre-emption to control potential inflation. This would be a pragmatic approach.