Sunday, June 7, 2009

India's growth : An inclusive agenda

The 2009 elections have attracted world-wide attention for the maturity displayed by the Indian electorate to give a decisive mandate to the UPA government. India clearly trusts the economist PM to lead as the economy faces the slowdown caused by the most severe global economic crisis since the 1930s. The PM and the finance minister have both stressed the importance of boosting the economy as their immediate priority.

The Indian economy has indeed been deeply hurt from the crisis with the GDP growth rate slowing down to 5.8% during the second half of 2008-09 compared to 9% achieved in the previous year. Even though a 6.7% growth recorded in full 2008-09 would put the Indian economy among the best performing, yet the damage has been extensive especially on SMEs, workers in the unorganised sector and other vulnerable groups. Exports have declined for seven months in a row especially in labour-intensive sectors such as handicrafts, apparel, gems and jewellery, resulting in job losses.

The previous government did take a number of steps including easing the monetary policy and fiscal steps such as subsidised home loans and incentives for exporters of labour-intensive goods. While these steps were in the right direction and were helpful, they need to be supplemented by many others to revive the growth momentum. The focus has to be on generation of additional demand to make up for the loss in the export markets and private investment activity.

Responses of most of the governments in the region have been on similar lines, although varying in terms of their relative magnitudes with the Chinese government’s fiscal package amounting to $586 billion (at 13% of GDP) being the most ambitious. The methods of distribution of fiscal impulses have varied, with most governments focusing on infrastructure investment while some have distributed cash among people (as in Japan).

In India’s case a stimulus package of the order of $50 billion (roughly 5% of GDP) spread over two financial years would be desirable. It would go a long way in reviving demand and restoring the growth sentiment. Additional spending of such a large sum also provides an opportunity to enhance the inclusiveness of resulting growth. The package should target the weaker sections of society to make the growth process more inclusive by paying special emphasis, for instance, on development of rural infrastructure such as rural roads and housing, primary and secondary education, health and sanitation. These would have high pay-offs in terms of growth and inclusiveness while having low import content.

A part of the package could be an adjustment fund for assisting the affected SMEs and workers. The national rural employment guarantee scheme should be extended to urban areas where most of the affected workers are likely to be found. With a much higher propensity to consume, a rural and pro-poor focus in the fiscal stimulus package would generate demand rapidly.

Sceptics would be concerned about the effects of such a large package on the fiscal balance and hence on inflation, keeping in mind the already stretched fiscal deficit in the current year. However, this is an exceptional year requiring an exceptional response. Most governments around the world are running huge fiscal deficits to revive demand. Furthermore, there is little risk of inflationary expectations in the present scenario of declining demand with inflation in India going down to under 1%.

The other steps the government could take include expediting the infrastructure projects. The national highway development programme could be expedited to make up for the lost time. Mr Kamal Nath, in his new role as the minister for surface transport, may push the highway construction with his customary zeal. The release of the sixth pay commission arrears to government employees could be frontloaded to get purchasing power in the market fast.

The Indian exporters need to be assisted by a cheap rupee policy especially when excess capacities are lurking on the horizon all around the country. However, as in 2007, rising FII inflows have begun to put upward pressure on rupee’s exchange rate. An 8% appreciation of rupee over a past few weeks puts a heavy adjustment burden on exporters while cheaper imports will further burden an already stretched current account deficit. Having witnessed the ill effects of the volatility caused by the FII inflows, India should take steps to moderate their inflows. Fortunately FDI inflows to India are growing robustly and should be relied upon for augmenting reserves, if at all.

To conclude, the time has come for taking bold steps to revive the growth momentum of the economy. India should seize the moment and inject a substantial stimulus while enhancing the inclusiveness of the growth process.

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