Tuesday, February 7, 2012

GDP slows down to sub-7% NDA-era levels….

The GDP growth is likely to slow down (again) to some 6.9% this year. The last time this happened was three years back in 2008-9 when it hit 6.8%. At that time, the slow-down was perhaps justifiable on grounds of the global financial crisis and its suddenness. An attempt is being made now by the government to explain the slip-up again on similar grounds. Except that this time, that’s not the real reason. The real reasons are different. Before we look into the real reasons, it is important for the Congress to understand the repercussions of a slowing GDP growth rate.

What the Congress may like to remember is that one of the reasons it got voted back to power in 2004 was the disappointment of the people with the economic growth achieved during the NDA government’s six years of rule. Here’re the official stats. During the NDA rule, the average GDP growth rate was 5.8%. In the five years prior to this, the GDP growth rate under Congress was 6.7%. And of course during UPA-1 the growth rate has been much higher at 8.4%. If the GDP rate slides for another year or more, the average growth during UPA-2 will be the same as it was during NDA rule and that will have potentially disastrous political consequences for the Congress. In many ways, the entire political strategy of the BJP has been to paralyze the working of the UPA, so that economic growth would slow down…..it looks like the BJP is succeeding.

Now coming to the story that the government is putting out – that global factors are responsible for our slow-down. This is a lot of rubbish. Let me prove it.

One of the important impacts of the global slow-down would be on our exports. For example, China is slowing down (a bit) because its economy is so export dependent. In India’s case however, our exports are only a small % of our GDP (exports some $300 billion; GDP some $1.7 trillion). Besides, in our case, the exports are actually doing fabulously well. For the April-December 2011 period, our exports growth was upwards of 25%. And even if there was some mistake with some components of the exports data, that was of a small order. We’ve seen export growth cooling off only in the last one-two months. So exports are clearly not the reason for our economy slowing down.

Let’s look at another global factor that could slow down our economy. In-bound FDI. Thanks to the big ticket FDI inflows into Reliance Industries and Posco, the FDI flowing in this year is expected to cross $35 billion – a huge increase from the $19.4 billion received last year and the $25 billion of a year earlier. This means that the Indian economy continues to attract investments from global corporates. We often confuse FDI investments with FII investments. It’s indeed true that FIIs withdrew substantially in CY2011 and that had a very negative impact on our stock markets and the rupee depreciation; but we must remember that FII money doesn’t impact GDP growth directly. It does so only indirectly. Sure, the declining stock market has led to fewer IPOs coming out and hence lesser direct investments in the economy. But the more direct impact on the economy is on account of FDI which has continued to defy any signs of global slow-down.

The real reasons for the economic slow-down are all internal. Some of them are temporary and some are more long-term. For eg., the farm sector growth rate has slowed down to 2.5%, from a level of 7% last year. Now the long term agricultural growth rate in India has hovered around 2.5% only – so it’s not that different this year. But this low growth rate slows down the overall performance of the economy. It has also been the reason for much of the inflation we saw throughtout the year – and the consequent rate hikes by the RBI which have led to a slow-down in manufacturing (which we’ll discuss next). Agricultural growth remains a long-term problem for our growth rate – and the only reason why it doesn’t have a more significant impact on overall GDP numbers is because the share of agriculture has now dropped to just some 15%. The government has done pretty much nothing in helping the growth in agriculture – investments in irrigation, electricity generation, fertilizers and pesticides have all been inadequate.

The other segment of the economy that has slowed down dramatically is manufacturing. Growth is down to 3.9% from 7.6% last year. This is a direct fall-out of high bank rates. Investments have slowed down as interest costs have soared. I must point out here, that the inflation that led to the bank rate hike was not in the manufacturing sector; it was in agriculture. Yet, the RBI went about (wrongly) increasing bank rates. These repeated bank rates did nothing to reduce the inflation in agriculture (inflation finally came down thanks to good monsoons), but they pushed the manufacturing growth rates down. This is poor management of the monetary policy, and though the RBI is independent of the government, the government does exercise a lot of control on the RBI. In an ideal world, the RBI and the Ministry of Finance must act together. Instead, it appears that the RBI has been let loose by the government.

There is another reason why the manufacturing growth has slowed down. There is an urgent need for reforms, but that’s simply not happening. There is a serious problem with mining and quarrying thanks to environment issues and the scams in states like Karnataka and the floods in Orissa. There is a serious power crisis, but we haven’t even been able to get Koodankulam started. Nor are our coal-based power plants in any great shape thanks to the coal shortages. A news story yesterday pointed out that the government has decided to reduce the 12th plan targets for power generation from 1 lac MWs to 75,000 MWs. If the targets are lowered, the actual results achieved will be even lower. This is poor governance.

Look at the construction sector. Again, the high bank rates, the rising input costs (steel, cement, labor), the change in policy regimes (application of Service Tax to construction), the slow-down in approvals (especially in Mumbai), the land acquisition problems (especially in Noida) and the corruption inherent in the sector – have all contributed to growth in this sector slowing down from 8% last year to 4.8% this year. This has nothing to do with external factors.

The only reason the GDP growth continues to remain half-decent is because of the growth in the services sector, which accounts for 55% of the overall GDP. Services grew by 9.4% compared to 9.3% last year. But in a country with so much unemployment, we need more manufacturing capability to go alongside the services sector. That again is sorely missing. The new manufacturing policy of the government has been in limbo for ever. The Delhi-Mumbai Industrial Corridor has finally been given the green signal, but its implementation is anyone’s guess. The new land acquisition policy is again much delayed. The reforms in the tax regime (especially GST) have missed several deadlines. Multi-brand retail, higher FDI limits in insurance, banking sector reforms, etc have all been running behind schedule. These are the real reasons why the economy has slowed down.

The direct consequence of the policy freeze has been that Indian corporates have started investing abroad. Out-bound FDI from India was a staggering $25 billion in the first 9 months of this year. Rahul Bajaj and other industrialists have been saying that they would rather invest outside than in India. The government has done nothing to address these concerns.

There is also a hell of a lot of politics that has led to the slowdown. The BJP has been unsupportive of reforms, its role in the FDI in multi-brand retail just one such example. The BJP doesn’t want the UPA to report fast growth rates – now that it is clearly established that people vote those governments back to power that deliver fast economic growths. The entire Anna movement and the Lokpal issue itself looked highly political – with the BJP playing at least some part in the politicization of that movement. The BJP has also been playing political games with the 2G issue – focusing on dragging Chidambaram (and the PM) into what was clearly Raja’s individual shenanigans. Not allowing Parliament to function has been another ploy the BJP has used – we saw that in the last session of Parliament when hardly a few bills were passed when there were more than 30 bills awaiting clearance.

The real truth is that the government cannot blame external factors for our slowing GDP growth. The factors are mostly internal. What we need is a strong government, which can on the one hand take on political challenges with aplomb, and on the other hand can push economic reforms with determination. Unfortunately, both of these have been lacking. If the matters continue this way, India will have lost an opportunity to rise up the global economic ladder. And Congress an opportunity to regain power in 2014…..

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