Not out of the woods just yet
The combined effects of a tightfisted central bank and a spendthrift government are showing up spectacularly in the first quarter of the current fiscal year. The economy grew a miserable 5.5% in April-June 2012, down from 8% in the same period a year ago. The loss of momentum endures from the immediately previous quarter when the gross domestic product grew by 5.3%, the slowest pace in nine years. Industry, apart from power, has stopped growing. Agriculture is slowing down, and the situation could get worse in the July-September monsoon quarter. The shocker in the latest data set is that the growth rate in the biggest chunk of services — trade, hotels, transport and communications — is less than a third of what it was a year ago. Contradictory policies have destroyed an awesome amount of demand in the economy over the space of 12 months. More destruction is in store unless the contradiction is resolved.
The Reserve Bank of India was correct in its assessment that persistent inflation called for tighter interest rates. The unsaid second leg of such policy intervention was spending curbs by the government, which never happened. Government consumption in April-June 2012 grew twice as fast as during the same quarter of 2011. Such prodigious expenditure is squeezing out private consumption — the stuff that you and I buy — which is now growing a fifth slower than a year ago. This is nothing in comparison to the havoc wreaked on investments. Real expenditure on setting up new production capacities in the economy has all but stopped growing. In effect, the government's profligacy is eating into household spending after having wiped out investment demand. The trade picture is not sunny either; the gap is closing because imports are growing slower than exports, not a healthy sign given our appetite for foreign energy. Here, too, capacity-enhancing machinery imports are taking the hit.
The situation — where current economic momentum as well as future growth prospects are being jeopardised by the ruling coalition's welfare commitments — can be salvaged by either fiscal rectitude or monetary easing. Expecting an election-bound government to see the light is a triumph of hope over reality. It would be far easier to mount pressure on the central bank to ease up on interest rates to revive growth. That would be a costly mistake. India is not out of the woods so far as inflation is concerned. There is a fair amount of suppressed and structural inflation that could rear its head. There seems to be a loose consensus among the country's principal political parties that short-term pain is acceptable if it translates into a better medium-term outlook for the economy. At this time, however, neither the present nor the future looks bright.