All around the world, things look a lot worse than they did two months ago. India is no exception. Growth for the last quarter of 2008, the 3rd quarter of fiscal year 2008-09, came in at 5.3 percent, but this was artificially inflated by pay hikes for central government employees. The state governments are going to follow suit later with their own pay increases, but much of the economy is showing weakness, including exports and manufacturing. The employment numbers are also discouraging.
On February 21st, Montek Ahluwalia, a key economic policy adviser, predicted 7 percent growth for 2009-10, based on three factors: a presumed recovery of the global economy by late 2009, the fiscal stimulus already announced, and plans for further fiscal stimulus. However, the first of these is now looking very unlikely, so private sector growth forecasts in the 5 percent range for 2009-10 seem much more likely. In fact, growth as low as 4 percent for the next fiscal year now seems a distinct possibility.
With headline inflation having collapsed, it was surprising that the RBI did not cut its policy rate on January 27th, as had been expected. They finally acted on March 4th, with a 0.5 percentage point cut. The apparent trigger was a drop in bank credit, seemingly reflecting weak demand. While India’s monetary transmission mechanism is weak, that was hardly an excuse for delaying monetary loosening. Meanwhile, it also seems that government spending is crowding out private investment. With fiscal deficits having soared, it seems to me that further interest rate cuts are necessary right away – it is easy to raise rates quickly when signs of life in the economy return. The case for monetary policy action also seems to be strengthened by the fact that elections are around the corner – I would guess that a transition in government will hamper fiscal action. Lags in spending are yet another reason for not relying on further fiscal stimulus.
Forthcoming elections also suggest that economic reform might stay on the back burner, which would be a pity. Further economic reforms could increase the potential as well as the actual rate of growth. Instead, it may be that India is in for a time of political uncertainty, which could also spook investors. Just when bold domestic policy action is needed, India may be in for a time of paralysis. I hope I am wrong, though.
Professor of Economics
University of California, Santa Cruz