Prime Minister Manmohan Singh has put a date to India’s exit strategy after the financial meltdown: 2010. Some time in the next year the government should begin slowing down economic expansion alongside a monetary contraction that is posed to get underway. From the looks of it, India is the first major economy to shrug off the global recession. Finance Minister Pranab Mukherjee is hopeful that the economy will grow 7 per cent in 2010-11 and reach its long-term trend rate of 9 per cent the year after. A more urgent — and impelling — argument for exit is inflation, where the base effect of last year’s record global energy and commodity prices has ebbed and food prices in India are ratcheting up in a drought year. The Reserve Bank of India expects wholesale prices are rising 30 per cent faster than its comfort level of 5 per cent.
The worst may be behind us, but it is a hard climb out of the fiscal hole the world has dug itself into. The public debt in the G20 — the 20 countries that produce 90 per cent of the world’s output — will climb from 62 per cent of gross world product in 2007 to 82 per cent in 2010 because of the largest coordinated bailout in history. It is a steeper climb for India, which went into the slump with an inordinately high debt ratio of 80 per cent and an ambitious social spending programme. Recession-induced discretionary spending is only a fraction of India’s overall fiscal expansion in 2009-10. Scaling down this component counter-cyclically does not address the issue of burgeoning subsidies and income transfers.
The timing of the exit is critical. Premature withdrawal of government spending risks nipping the recovery in the bud. On the other hand, if the government continues to pump more money than is needed, rising interest rates will undermine whatever revival has been achieved. But whenever it does, India’s rollback will have to be large. To regain its pre-crisis position, India needs to bring down its fiscal deficit from 6.8 per cent to 2.7 per cent, a process that could occupy this government for the rest of its term. A recurrent theme for Manmohan Singh’s second term will be the inherent conflict between its welfare politics and fiscal prudence.