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Economic Outlook, Prospects, and Policy Challenges

  • India’s economic performance can be measured against two distinct benchmarks:
    • India versus other countries; and
    • India versus its own medium-term potential.
  • On the first, the Indian economy has fared well; on the second, steady progress is being made and there is still scope for translating potential into actuality.
  • India’s Potential GDP Growth
  • India is oozing potential. That is undeniable.
  •  economists measure a country’s potential GDP growth in two ways:
    •  by extrapolating from past growth
    • by projecting the underlying drivers of growth: capital (physical and human), labor, and productivity
  • Global Context
    • the time period bet ween the successive economic crisis is decreasing
    • India’s debt to GDP ratio (centre + state)= 67%
  • overall index of macroeconomic vulnerability, which adds a country’s fiscal deficit, current account deficit, and inflation.
  • India’s investment grade (BBB),
  • Rational Investor Ratings Index (RIRI) which combined two elements, growth serving as a gauge for rewards and the macro-economic vulnerability index proxying for risks.
  • The fiscal sector registered three striking successes:
    • ongoing fiscal consolidation,
    • improved indirect tax collection efficiency; and
    • an improvement in the quality of spending at all levels of government.
  •  India’s exports of manufactured goods and services now constitute about 18 percent of GDP, up from about 11 percent a decade ago.
  • There are three significant downside risks.
    • Turmoil in the global economy could worsen the outlook for exports and tighter financial conditions significantly
    •  if contrary to expectations oil prices rise more than anticipated, this would increase the drag from consumption, both directly, and owing to reduced prospects for monetary easing.
    •  the most serious risk is a combination of the above two factors. This could arise if oil markets are dominated by supply-related factors such as agreements to restrict output by the major producers
  • Twin balance sheet (TBS) problem

    • —the impaired financial positions of the Public Sector Banks (PSBs)
    • and some large corporate houses
    • Solutions

      • Resolving the TBS challenge comprehensively would require 4 Rs : Recognition, Recapitalization, Resolution, and Reform.
      • Banks must value their assets as far as posible close to true value (recognition) as the RBI has been emphasizing;
      • once they do so, their capital position must be safeguarded via infusions of equity (recapitalization) as the banks have been demanding
        • where would resources for recapitalization would come from given that government is committed to the path of fiscal consolidation?
          • 1. Divest govt. equities in non financial companies and invest in PSBs
          • 2. Dilute RBI’s capital to capitalize banks
          • 3. govt can dilute its equity in banks to raise resources from the market
      • the underlying stressed assets in the corporate sector must be sold or rehabilitated (resolution) as the government has been desiring
      • future incentives for the private sector and corporates must be set right (reform) to avoid a repetition of the problem,
  • the evolution of the debt-to-GDP ratio depends on two factors.
    •  (i) the level of the primary deficit, that is, the fiscal deficit once interest costs are set aside; and
    • (ii) the difference between the interest rate on government debt and the growth of nominal GDP
  • the correlation between India’s growth rate and that of the world has risen sharply to .42 from .2 for the period 1991- 2002 i.e. 1 % decrease in the world growth rate # 0.42 % decrease in Indian growth rates
  • Realizing long term potential growth of 8-10% requires a push on at least three fronts-
    1. Creating genuinely pro competitive market by allowing inefficient firms to exit (Chakravyuha challenge) –
      1. Govt response- new bankruptcy code
    2. major investments in people— health and education- to exploit India’s demographic dividend.
    3. Don’t neglect agriculture as 42% of Indian households derive the bulk of their income from farming. Smaller farmers and landless laborers especially are highly vulnerable to productivity, weather, and market shocks changes that affect their incomes.
      1. Govt response – PM Fasal Bima Yojana
  • India and WTO

    • Two issues in agriculture-

      •  Special safeguard mechanism (SSM)
      • which came for discussion in Nairobi ministerial meeting
      • ssm embodies the right to impose trade barriers if there is a sutge in agricultural imports to india
        • The question which arises is whether India even needs such protection
        • We are already allowed tariff from 40 per cent to 100 per cent (India’s modal rate in agriculture) to 150 per cent.
        • In a preponderance of tariff lines, there is a considerable gap between applied tariffs and the level of tariff binding
        • In dia’s only real need for SSM arises in relation to a small fraction of its tariff lines—some milk and dairy products, some fruits, and raw hides— where its tariff bindings are in the range of about 10-40 percent, uncomfortably close to India’s current tariffs, limiting India’s options in the event of import surges
      • Food security/ stockholding issue
        • The particular policies (MSP) which are being defended are those that India intends to move out of in any case because of their well-documented impacts:
        • decline in water tables, over-use of electricity and fertilizers (causing health harm), and rising environmental pollution, owing to post-harvest burning of husks
        • the government is steadfastly committed to providing direct income support to farmers and crop insurance which will not be restricted by WTO rules
  • way forward in WTO on agriculture
    • India should consider offering reduction in its very high tariff bindings and instead seek more freedom to provide higher levels of domestic support: this would be especially true for pulses going forward where higher minimum support prices may be necessary to incentivize pulses production
  • Three sets of responses-
    • Exchange rate. Keep rupee’s value fair, avoid strengthening using some combination of monetary relaxation, allow gradual declines in the rupee if capital flows are weak, intervention in foreign exchange markets if inflows are robust.
    •  India should strengthen procedures that allow WTO-consistent and hence legitimate actions against dumping (anti-dumping), subsidization (countervailing duties), and surges in imports (safeguard measures) to be taken expeditiously and effectively.
    • India should eliminate all the policies that currently provide negative protection for Indian manufacturing and favor foreign manufacturing.Implement GST asap.