5 factors that slowed down the economy
Sep 14 2011 , New Delhi
The turbulence in the global financial markets t is likely to mount depreciation pressure on rupee against the US dollar. t In comparison with the t developed world, the Indian economy continues to gallop at an impressive rate. However, some observers have expressed r concern about the recent slowdown in the growth rate. In the first quarter of financial year 2011-2012, the Indian economy registered a growth rate of 7.7 per cent compared with an impressive growth of 9.3 per cent in the same quarter last year. This was the slowest growth rate in six quarters. In last quarter that ended March 2011, the growth had sharply fallen to 7.8 per cent.
The United Nation Conference on Trade and Development (Unctad), in a report published earlier this week, lowered the growth forecast to 8.1 per cent in 2011-2012 compared with 8.6 in the previous year. The Prime Minister's Economic Advisory Council (PMEAC), in July, had revised the growth rate to 8.2 per cent downwards citing inflationary concerns and precarious global economic situation.
In the first quarter of 2011-12, India's burgeoning service industry registered sluggish growth rates -the lowest in two years. The manufacturing sector continued its downtrend and the rate of growth was at a 29-month low.
As policy gurus continue to debate the reasons behind this unhappy trend, it has become abundantly clear that a number of factors have acted in tandem and contributed to dampening the growth trajectory. So what are the factors ailing the economy?
INFLATION
As the country at large continues to reel under the brunt of rising inflation, there is little doubt that this factor has significantly undermined growth. Rising global commodity prices have exacerbated the inflationary trend in the domestic economy. Inflation data for the week ending August 27 showed some sign of abating, albeit marginally. Food price index fell to 9.55 per cent compared with 10.55 per cent last week. The government is grappling with a lot of issues, but inflationary concerns figure prominently in its list of worries.
RBI, in its Annual Report 2010-11, devotes a significant part to the growth-inflation trade off. It notes that inflation could adversely impact factors like growing openness, growth in investment demand and fiscal consolidation. External competitiveness will also come under intense pressure if high inflation continues. The fiscal situation may deteriorate in an environment of very high inflation. Furthermore, the monetary response to inflation will augment the cost of capital. “In pursuing the anti-inflationary policy, however, it is important for a central bank to identify the threshold level of inflation, which may be consistent with the highest sustainable growth path,“ the report cautions. In consonance with this objective, the RBI emphasises in the report that the perception of inflation should be between 4-4.5 per cent. A rate higher than this will have a debilitating effect on the economy.
INTEREST RATES
In an aggressive bid to tame unbridled inflation, RBI raised its policy rates the rates at which the RBI lends money to banks and keeps deposit of their surplus funds 11 times in 18 months. This has only constrained the demand for important consumer durables.
Monetary tightening has also hampered the level of investment in the economy, which has consequently impacted growth. But this hawkish tactic has been unsuccessful in taming the alarming rise in prices.
“Both cost-push and demand pull inflation have impacted the growth rate,“ said Dr BL Pandit, RBI chair professor at Indian Council for Research on International Economic Relations (ICRIER).
“Raising the rate of inter est simply increases the cost of borrowing for private sector investment while wasteful government spending goes unchecked. It hurts growth in general and stultifies growth of small and medium level business in particular. The reason is that while big companies can borrow from abroad at cheaper interest rates, small businesses cannot do so.
Jobs are lost in this process because most small business firms use labour intensive techniques. So let the government think of putting an end to the misery generated by its policy of fighting inflation exclusively through escalation of interest rates,“ he adds.
“A further increase in rates will have a limited impact on reining in inflation. Given the current scenario, a further increase could in fact be counterproductive,“ says Dr Ramgopal Agarwala, a distinguished fellow at the Research and Information System for Developing Countries (RIS) based here.
DK Joshi, chief economist at CRISIL, told FC that the, “investment activity has slowed down due to policy inertia, sagging confidence and high interest rates.“
STRUCTURAL ISSUES
The Economic Outlook Report submitted to the prime minister draws attention to the weakness in the gross domestic fixed capital formation. “High rates of domestic inflation, excessive government debt, political instability and the global situation have eroded business confidence impacting asset creation adversely,“ the report goes on to say.
Discernible structural constraints do exist. It was this reason that India cannot hope to grow at or beyond 9 per cent.
Infrastructural constraints, a poor water management policy, deeply ingrained rigidities in the labour market, high fiscal deficit and energy constraints are also the reasons that the economy is struggling to grow beyond 9 per cent.
“India's growth is limited by three major factors: physical infrastructure, social infrastructure (the health, education and skill levels of the labour force), global uncertainty, and the policy drift and incoherence that affects the government's ability to do anything about the two former constraints.
However, I think it would be an exaggeration to talk about the slow growth of India. Even at 7-8%, it is almost the highest rate of growth in the world, and much higher than anything the developed countries ever managed. It seems our expectations were unduly raised in the last few years,“ says Professor Aditya Bhattacharjea at the Delhi School of Economics.
GLOBAL SCENARIO
Dr Rajiv Kumar, secretary general of the Federation of Indian Chambers of Commerce and Industry (Ficci), said the manufacturing and industrial growth will come under pressure. “Given the del icate nature of the interna tional environment and the Rerserve Bank of India's deci sion to hike rates, the manu facturing and industrial sec tors are bound to be affected. These are tough times for the industry,“ he said.
The global economic pic ture is far from saccharine. Economic indicators are creating an environment which is not conducive to growth. The US continues to be saddled with debt and the Euro economies contin ue to fester under worsen ing financial and economic conditions.
The World Economic Outlook Update, released by the International Monetary Fund (IMF) in June under scores the gravity of the situ ation. “Activity is slowing down temporarily, and downside risks have increased again. The global expansion remains unbal anced. Growth in many advanced economies is still weak, considering the depth of the recession. In addition, the mild slowdown observed in the second quarter of 2011 is not reassuring,“ the report notes.
Under these circumstances one can expect these factors to have repercussions for India.
Fluctuations in the currency and equity market, and an unrestrained rise in the commodity prices have grave ramifications for “ “ Rajiv Kumar Secretary general of Ficci growth. The UNCTAD report has projected a meager growth rate of 3 per cent for the global economy.
Laggard growth will adversely impact Indian businesses which have operation in the developed world.
“We expect Indian economy to grow at 7.7-8 % in 2011-12 under the assumption that growth in developed economies will slow sharply, but they will avoid another recession. The first quarter data for 2011-12 shows that interest rate hikes have tempered both household consumption and investment demand. In this scenario, heightened risks of a double dip in advanced economies create serious downside risks for India's growth,“ DK Joshi said.
GOVERNANCE DEFICIT
As scams continue to keep the government on tenterhooks, the business community is clearly seething. The government is in the midst of a policy paralysis, and it is finding it increasingly difficult to restore investor confidence. It has diverted considerable energy in salvaging a tarnished reputation, which has stalled the economic reform process.
Although the effect is intangible, many would agree that scams and corruption induced investment have manifested themselves in the slow rate of growth; at least in the short run.
The draft approach for the 12th five year plan, released by the planning commission, notes that, “large scale corruption occurs either because of mishandling of government contracts, or because discretionary decision making in some areas is used to the advantage of some.
Corruption undermines the legitimacy of the system in the eyes of the public and reduces potential for achieving efficiency through competition... rapid economic growth has meant sharp increase in the value of many scarce resources, e.g., minerals, or spectrum or land and as long as these are allocated on the basis of discretion exercised in a non transparent manner, the likelihood of corruption increases“.
Regarding the decision making apparatus, the draft approach calls government ministries `silos'. This has made the decision making process an excruciating task.
“Governance was most widely indicated as an area of concern in the interactions that we had with different stakeholders in the past eight months,“ Montek Singh Ahluwalia, the Deputy Chairman of the Planning Commission, said in an interview to FC last week.
India, however, remains the world's second fastest growing economy after China. Despite the departure from the stellar rates recorded in earlier years, India is still registering respectable rates when compared to the languishing economies of the developed world.
The United Nation Conference on Trade and Development (Unctad), in a report published earlier this week, lowered the growth forecast to 8.1 per cent in 2011-2012 compared with 8.6 in the previous year. The Prime Minister's Economic Advisory Council (PMEAC), in July, had revised the growth rate to 8.2 per cent downwards citing inflationary concerns and precarious global economic situation.
In the first quarter of 2011-12, India's burgeoning service industry registered sluggish growth rates -the lowest in two years. The manufacturing sector continued its downtrend and the rate of growth was at a 29-month low.
As policy gurus continue to debate the reasons behind this unhappy trend, it has become abundantly clear that a number of factors have acted in tandem and contributed to dampening the growth trajectory. So what are the factors ailing the economy?
INFLATION
As the country at large continues to reel under the brunt of rising inflation, there is little doubt that this factor has significantly undermined growth. Rising global commodity prices have exacerbated the inflationary trend in the domestic economy. Inflation data for the week ending August 27 showed some sign of abating, albeit marginally. Food price index fell to 9.55 per cent compared with 10.55 per cent last week. The government is grappling with a lot of issues, but inflationary concerns figure prominently in its list of worries.
RBI, in its Annual Report 2010-11, devotes a significant part to the growth-inflation trade off. It notes that inflation could adversely impact factors like growing openness, growth in investment demand and fiscal consolidation. External competitiveness will also come under intense pressure if high inflation continues. The fiscal situation may deteriorate in an environment of very high inflation. Furthermore, the monetary response to inflation will augment the cost of capital. “In pursuing the anti-inflationary policy, however, it is important for a central bank to identify the threshold level of inflation, which may be consistent with the highest sustainable growth path,“ the report cautions. In consonance with this objective, the RBI emphasises in the report that the perception of inflation should be between 4-4.5 per cent. A rate higher than this will have a debilitating effect on the economy.
INTEREST RATES
In an aggressive bid to tame unbridled inflation, RBI raised its policy rates the rates at which the RBI lends money to banks and keeps deposit of their surplus funds 11 times in 18 months. This has only constrained the demand for important consumer durables.
Monetary tightening has also hampered the level of investment in the economy, which has consequently impacted growth. But this hawkish tactic has been unsuccessful in taming the alarming rise in prices.
“Both cost-push and demand pull inflation have impacted the growth rate,“ said Dr BL Pandit, RBI chair professor at Indian Council for Research on International Economic Relations (ICRIER).
“Raising the rate of inter est simply increases the cost of borrowing for private sector investment while wasteful government spending goes unchecked. It hurts growth in general and stultifies growth of small and medium level business in particular. The reason is that while big companies can borrow from abroad at cheaper interest rates, small businesses cannot do so.
Jobs are lost in this process because most small business firms use labour intensive techniques. So let the government think of putting an end to the misery generated by its policy of fighting inflation exclusively through escalation of interest rates,“ he adds.
“A further increase in rates will have a limited impact on reining in inflation. Given the current scenario, a further increase could in fact be counterproductive,“ says Dr Ramgopal Agarwala, a distinguished fellow at the Research and Information System for Developing Countries (RIS) based here.
DK Joshi, chief economist at CRISIL, told FC that the, “investment activity has slowed down due to policy inertia, sagging confidence and high interest rates.“
STRUCTURAL ISSUES
The Economic Outlook Report submitted to the prime minister draws attention to the weakness in the gross domestic fixed capital formation. “High rates of domestic inflation, excessive government debt, political instability and the global situation have eroded business confidence impacting asset creation adversely,“ the report goes on to say.
Discernible structural constraints do exist. It was this reason that India cannot hope to grow at or beyond 9 per cent.
Infrastructural constraints, a poor water management policy, deeply ingrained rigidities in the labour market, high fiscal deficit and energy constraints are also the reasons that the economy is struggling to grow beyond 9 per cent.
“India's growth is limited by three major factors: physical infrastructure, social infrastructure (the health, education and skill levels of the labour force), global uncertainty, and the policy drift and incoherence that affects the government's ability to do anything about the two former constraints.
However, I think it would be an exaggeration to talk about the slow growth of India. Even at 7-8%, it is almost the highest rate of growth in the world, and much higher than anything the developed countries ever managed. It seems our expectations were unduly raised in the last few years,“ says Professor Aditya Bhattacharjea at the Delhi School of Economics.
GLOBAL SCENARIO
Dr Rajiv Kumar, secretary general of the Federation of Indian Chambers of Commerce and Industry (Ficci), said the manufacturing and industrial growth will come under pressure. “Given the del icate nature of the interna tional environment and the Rerserve Bank of India's deci sion to hike rates, the manu facturing and industrial sec tors are bound to be affected. These are tough times for the industry,“ he said.
The global economic pic ture is far from saccharine. Economic indicators are creating an environment which is not conducive to growth. The US continues to be saddled with debt and the Euro economies contin ue to fester under worsen ing financial and economic conditions.
The World Economic Outlook Update, released by the International Monetary Fund (IMF) in June under scores the gravity of the situ ation. “Activity is slowing down temporarily, and downside risks have increased again. The global expansion remains unbal anced. Growth in many advanced economies is still weak, considering the depth of the recession. In addition, the mild slowdown observed in the second quarter of 2011 is not reassuring,“ the report notes.
Under these circumstances one can expect these factors to have repercussions for India.
Fluctuations in the currency and equity market, and an unrestrained rise in the commodity prices have grave ramifications for “ “ Rajiv Kumar Secretary general of Ficci growth. The UNCTAD report has projected a meager growth rate of 3 per cent for the global economy.
Laggard growth will adversely impact Indian businesses which have operation in the developed world.
“We expect Indian economy to grow at 7.7-8 % in 2011-12 under the assumption that growth in developed economies will slow sharply, but they will avoid another recession. The first quarter data for 2011-12 shows that interest rate hikes have tempered both household consumption and investment demand. In this scenario, heightened risks of a double dip in advanced economies create serious downside risks for India's growth,“ DK Joshi said.
GOVERNANCE DEFICIT
As scams continue to keep the government on tenterhooks, the business community is clearly seething. The government is in the midst of a policy paralysis, and it is finding it increasingly difficult to restore investor confidence. It has diverted considerable energy in salvaging a tarnished reputation, which has stalled the economic reform process.
Although the effect is intangible, many would agree that scams and corruption induced investment have manifested themselves in the slow rate of growth; at least in the short run.
The draft approach for the 12th five year plan, released by the planning commission, notes that, “large scale corruption occurs either because of mishandling of government contracts, or because discretionary decision making in some areas is used to the advantage of some.
Corruption undermines the legitimacy of the system in the eyes of the public and reduces potential for achieving efficiency through competition... rapid economic growth has meant sharp increase in the value of many scarce resources, e.g., minerals, or spectrum or land and as long as these are allocated on the basis of discretion exercised in a non transparent manner, the likelihood of corruption increases“.
Regarding the decision making apparatus, the draft approach calls government ministries `silos'. This has made the decision making process an excruciating task.
“Governance was most widely indicated as an area of concern in the interactions that we had with different stakeholders in the past eight months,“ Montek Singh Ahluwalia, the Deputy Chairman of the Planning Commission, said in an interview to FC last week.
India, however, remains the world's second fastest growing economy after China. Despite the departure from the stellar rates recorded in earlier years, India is still registering respectable rates when compared to the languishing economies of the developed world.
The article was first published in the Financial Chronicle
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