Looking Back, Looking Ahead

2010 has been a good year for the economy, and 2011 could be better if we manage the risks

 

           Political news continues to dominate the headlines, unfortunately for all the wrong reasons. If you are looking for something to cheer you up for the New Year, turn to the news on the economic front. 2010 has been a good year, and 2011 could be better if we can manage the risks.
   High growth is back. Midyear estimates for 2010-11 indicate that the economy is currently growing at an annual rate of 8.9%. Moreover, the high growth is well dispersed, which augurs well for its sustainability through 2011 and beyond. Agriculture is lagging behind with a growth rate of less than 4%. So also the utilities sector – electricity, gas and water supply – growing at less than 5%. All other sectors are growing at over 8%. Some major sectors like manufacturing, transport, communications, wholesale and retail trade, hotels and tourism are growing at remarkable rates of over 11%.
   On the demand side, private consumption, capital formation and exports, the three largest components of aggregate demand, are growing at 10.6%, 14.9% and 10.1% respectively in real terms. Responding to this robust growth performance, the stock price index has also climbed back to 20,000. It last reached this level in early 2008 before the global financial crisis triggered its tailspin down to 7,000.
   Alongside this buoyancy, there are also some adverse developments. These are risks that will have to be managed if the high growth of 2010 is to be sustained or bettered in 2011. The immediate worry is inflation. Consumer prices continue to increase at near double-digit levels (9.7%), a trend recently dramatised by the sharp rise in onion prices. Currently food prices are inflating at an annual rate of over 12%. The other major source of rising consumer prices is the price of crude oil and related products. These prices are inflating at an annual rate of around 15%, but could go higher if global crude prices keep climbing towards $100 a barrel or more.
   For several quarters now, the RBI has been tightening monetary policy to curb inflationary
pressures. Commodity specific interventions have also been introduced to stabilise those food prices that have risen most sharply, such as onions now and sugar earlier. However, the government’s basic fiscal policy stance has remained expansionary. The finance minister announced recently that the fiscal stimulus will be retained for some more time, implying a large deficit again in the Budget for 2011-12.
   At first glance, this is puzzling, since the main worry now is inflation not growth, and that would call for fiscal compression. However, the finance minister may be anticipating further increases in the price of oil, and providing for compensation to oil companies if they are prevented from fully passing on the price increases to consumers. Hence, paradoxically, the main aim of the deficit may indeed be containing inflation.
   A second major risk is the continuing sovereign debt crisis in Europe. After Greece and Ireland, Spain, Portugal and Italy are the next in line for a potential sovereign debt default. If one or more of these countries do default, the effects will be transmitted to India via two main channels. One is trade. A further slowdown or recession in Europe will hurt India’s exports to Europe, and hence its growth. However, that effect will be muted so long as India’s other major trading partners, especially China and the US, remain buoyant. Indeed, growth in the EU area as well as Japan has been quite depressed this year, but its impact on India is barely visible.
   The other transmission channel is flow of capital. The volumes of sovereign debt in the countries at risk are not large enough for such defaults to trigger another global recession. In fact, such an event could further divert capital flows from Europe to less risky emerging markets like India, as is already happening to some extent. The recent bull run in the stock market, like that of 2007, has been led by the inflow of portfolio investments from foreign institutional investors. This is not an unmixed blessing. The resulting rupee appreciation has hurt the growth of exports, and a sudden stop or reversal of these flows could again destabilise the market. However, with the US economy recovering, fuelled by Barack Obama’s recent tax cut Bill and exceptional monetary expansion, a second global recession seems improbable. On balance, while Europe remains a negative factor, it is not likely to derail high growth in India.
   The third and most important risk is political, the deficit of good governance. Nitish Kumar’s resounding victory in Bihar reinforces the signals from other recent elections, that performance is finally replacing political mobilisation based on caste and religion. Daily revelations about multiple scams, from looting of 2G spectrum sale money and Commonwealth Games money to Adarsh Society and other land allocation deals also suggest that while corruption is widespread and deep-seated, some institutional safeguards are still working. On the other hand, selective targeting of investment proposals has spread great nervousness in the corporate world. Political patronage or the lack of it, not performance, will still be the main determinant of economic success in 2011. The more things seem to change, the more they remain the same.