The pre-election debate about the health of the economy has generally revolved around the expectations from the new government and an assessment of the work done by the outgoing UPA-II. The economy which was struggling with twin deficits, fiscal and current account along with a falling rupee and high and stubborn inflation appeared to be headed for disaster by the middle of 2013.
With low investor confidence, an impasse on major policy issues and the RBI’s inability to arrest the free fall of the rupee, it looked as if there was no easy way out. However, as we approach the polling for the elections, the macroeconomic conditions appear to have changed.
The rupee has strengthened, inflation has declined, current account has improved and fiscal deficit at 4.6 per cent of GDP for FY14 is lower than the budgeted figure. Thanks to the monsoon, exports, passage of some reforms related Bills in Parliament, and deft management by the RBI, the outlook for the Indian economy is looking significantly better now than the middle of 2013.
Does this mean the outgoing government did a good job on the economic front? Certainly not. However, before discussing what is ailing the economy today, it may be worthwhile to take a look at the reasons that propelled India’s GDP growth to record levels during 2003-08, the period that coincided with UPA-I.
On the domestic front, the full benefit of the reforms initiated since 1991 emerged only by 2003. During that period industrial de-licensing, trade reform, banking reform, exchange-rate changes and FDI regime together created a business environment conducive for investment and growth. GDP growth in 2003-04 therefore accelerated to eight per cent and remained high, until the global financial crisis pulled it down to 6.7 per cent in 2008-09.
During 2003-08, the fiscal deficit narrowed; although the narrowing was more due to increased tax revenues than reduced expenditure, it did free up resources for investment. The investment-to-GDP ratio reached its peak of 38.1 per cent in 2007-08. The combined fiscal deficit of the Centre and the states dropped to 4.1 per cent during the year, from 8.4 per cent in 2003-04.
On the external front, global liquidity surged, and the world GDP grew at an average of 4.4 per cent during 2003-08, compared with 3.4 per cent during 1997-02.
Benefiting from both favourable global conditions and competitiveness unleashed by a decade-long economic reforms, India's exports of goods and services soared: their share in the GDP rose from 15 per cent in 2002-03 to about 22 per cent in 2012-13.
But the domestic and external factors that propelled India’s GDP growth to record levels during 2003-08 have remained less favourable post the 2008 global crisis. On the global front, although growth prospects in the US have somewhat improved lately, growth in the Euro-zone is anaemic due to deleveraging and upside to GDP growth in China is getting limited due to focus on controlling risks. In nutshell the prospect for global growth continues to be fragile.
The domestic macro environment although has improved as compared to mid-2013, the period of 2009-2013 was marred by high inflation, gridlock on the policy front, and dwindling GDP growth in the government. While there is little the outgoing government could have done to boost the global macro environment, there is plenty it could have done on the domestic front.
After the 2008 crisis, the fiscal and monetary stimuli that spurred consumption demand did raise the GDP growth. However, they also sowed the seeds of the challenges that the Indian economy is facing today as it increased demand without easing the supply side constraints. The high growth was, therefore, accompanied by inflationary pressures.
To tame inflation, the RBI reversed the monetary policy stance and pursued a tight monetary policy leading to higher interest rate. This dragged down both investment and consumption demand in the economy.
The second slowdown thus came rather quickly and GDP growth fell to 4.5 and 4.9 per cent in 2012-13 and 2013-14 respectively.
The challenge today therefore is to ease supply side bottlenecks by stimulating investment and thereby improving the productivity and productive capacity of the economy. This is the single most important area where UPA-II failed and the investment-to-GDP ratio declined from 38.1 per cent in 2007-08 to 35.6 per cent in 2012-13 and incremental capital output ratio (ICOR) for the same period increased from about four to eight.
Clearly, bringing about structural reforms that created the business environment and unleashed the entrepreneurial energy conducive for investment during 2003-08 is the need of the hour. The green shoots that have emerged in the economy lately on this front needs to be nurtured further.
The total value of mega projects stalled since 2009 and now cleared by the Cabinet Committee on Investment up to February 18 aggregates to Rs 5,409.6 billion (4.6 per cent of the GDP).
However, these investments may not see the light of the day despite clearances if the new government slips on account of structural reforms which include implementation of goods and services tax (GST), passage of the mines and minerals Bill 2011, a more simplified tax platform, the direct tax code (DTC), public procurement Bill 2012 etc.
Also speeding up the work on Delhi-Mumbai industrial corridor, improving the funding environment or availability of funds for long-term infrastructure projects would be a plus for stimulating private investment, which was the key driver behind capex during 2003-08.
Finally, on the question that the next five years would depend on which political party forms the next government history shows that the broad framework of economic reforms and policies initiated since 1991 has remained intact irrespective of the political party that formed the government and also many of economic reforms took place when government was in minority.
