India's growth prospects, it is generally agreed, should improve in the next year. That is because the global outlook has improved. One indication is the return of FII flows into India in a big way- net FII inflows this calendar year are over $20 bn, the same as in 2010. FII money fled India last year following the Eurozone crisis. The relatively stability in the Eurozone this year has prompted a return.
Note that FII flows did not return because of the burst of reforms. The bulk of the FII flows , $12 bn out of $20 bn, came into the country by August whereas the reform burst happened in September. This underlines an important point: what happens to the economy in the near future will be governed more by global conditions that any reform initiatives.
This proposition is borne out by the fact that India grew at 8-9% in 2004-08 without any serious reforms. Similarly, growth plummeted to 6.8% in 2008-09 at the peak of the global crisis. India's economy is far more integrated with the world economy than before through both trade and capital flows. Another reason the global economy matters is more is that private investment in infrastructure, which drove growth earlier, is hampered now by regulatory and legal issues and high leverage in infrastructure companies. We can't really expect domestic investment to drive growth in a big, given the difficulties in the big growth area, infrastructure.
As for reforms, the potential impact of these is constrained by two factors. One, the persistence of high inflation- this won't change in the next two to three years as domestic prices are gradually aligned with international prices. Two, the fiscal deficit will remain high upto 2014 if only for electoral reasons. Both these will mean a low rate of savings. High inflation will keep financial savings low as households prefer to park their savings in gold. A high fiscal deficit implies lower net savings. The fiscal deficit will decline substantially only when growth revives strongly on the back of a revival in global demand. It is unrealistic to expect that we can compress fiscal deficit to a level where interest rates fall, investment revives and growth accelerates.
Whichever way you look at it, the global outlook holds the key to India's return to the growth path of 8%. The Eurozone crisis will stretch out until at least 2014-15. That implies that India will have to wait at least until then before it gets to seeing growth of 8%.
More in my ET column, Slow return to 8% growth.