Thursday, December 20, 2012

Global economy more crucial to growth than reforms

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.


Rajesh Rikame said...


What kind of an effect do you expect this burst of reforms, if implemented, will/can have on India's growth story?

Reflections Of Vishal V Kale said...

Excellent Analysis....

Anonymous said...

This is the sort of conclusion you get when you focus on next year's growth as opposed to the growth for the next decade. You should change the title to say: Global economy more crucial to short-term growth than reforms. With the obvious corollary that reforms are more important for long term growth. Fairly obvious points, isn't it? And, what do you think should be the focus - short term or long term?

T T Ram Mohan said...

R@J: As anonymous below points out, these reforms will have some effect over a very long period (especially FDI in retail). Improvements in efficiency, stemming from reforms, should help lift growth but the impact of the particular reforms we have had should not be exaggerated. I would imagine that improvements in education and healthcare would be more important.

Anonymous, I was trying to make the point that the current bout of reforms should not be viewed as a quick fix for the slump in growth.

There is little point in focusing on the short-term because, in the short-term, it is the global factors that are going to dominate.There is also the issue of growth versus equity (which is implicit in debates on land acquisition policy and the like) which I have not alluded to.


Anonymous said...

Ah ok, but the problem I see with the article is that it states the reason for lower growth in the short-term and leaves it at that.

The title is open to the common mis-interpretation that it is the global economy to blame and reforms won't help, without the caveat of short/long term.

Experts should be saying the opposite to the policy makers and the people: forget about the global economy, but lets do x,y,z reforms as that is what will determine long term prospects. Furthermore, it should not come as a surprise to most people, least of all policy makers, that the global economy is in a funk.

I know this might look like nit picking and its fairly obvious, but there is a culture of blaming the global economy for all our woes (and not attributing good things to anything but the fabulous India story), which should not be an escape route for policy makers. Ofcourse, such thinking is great for animal spirits, and promoting risky investments. So, excessive confidence has its benefits. :)

Also, I'm curious to know whether you agree that FDI is indeed meaningful reform? I find it dubious because its not like there is shortage of domestic capital in the country. In fact domestic capital has been vocal about bad governance and going to other countries for investment opportunities. And, true reform would have been on the govt side of things - governance, infra, etc. I'm overly cynical on FDI, to the extent that I think FDI is an easy option out to get some new naive investors (bakras) into the market, to mask deep flaws in the public sector responsibilities in this sector. It might still be useful, and in turn lead to better quality governance too, but its not what experts should be lauding or calling for? Do you agree?

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