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The Hindu : Columns / Chandrasekhar : The growth trap

Opinion Columns Chandrasekhar

Published: June 3, 2012 13:57 IST | Updated: June 3, 2012 13:57 IST

The growth trap

C. P. Chandrasekhar

News that GDP growth has slowed considerably to 5.3 per cent in the fourth quarter of 2011-12, as compared with 9.2
per cent in the corresponding quarter of the previous year, could not have come at a worse time for the government.
While quarterly GDP estimates tend to be revised substantially, the evidence that the GDP growth rate has been
consistently declining over the four quarters of the last financial year and that the fourth quarter rate is the lowest in
nine years makes it imperative for the government to respond.
However, other aspects of the emerging economic scenario make the choice of that response difficult. There are three
disconcerting aspects of that scenario that are being widely referred to. The first is inflation, which had moderated
and the government was hoping would just go away. However, the annual month-on-month rate of inflation as
measured by the national Consumer Price Index had risen to 10.4 in April, from 9.4 per cent in March, 8.8 per cent in
February and 7.7 per cent in January. Hence, the government may find it difficult to persuade the Reserve Bank of
India to announce a substantial reduction in interest rates in order to spur growth. Even if the impact of a reduction
of interest rates on growth is not likely to be dramatic, such a move would have served to signal decisive action.
The second is the evidence that lower export growth resulting from the global recession combined with a rising bill on
account of both oil and non-oil imports is widening the trade and current account deficits with attendant adverse
effects on GDP growth. The deficit in the net exports component of GDP has risen from around Rs 316,000 to Rs.
413,000, and contributes to dampening rather than facilitating growth.
Thirdly, international investors are being less enthusiastic about investing in India, partly because of challenges they
are facing elsewhere in the world. That is adversely affecting the rupee that is already weakened by the rising current
account deficit, leading to s sharp depreciation of the currency.
These features of the current scenario are hindering the governments resort to the most obvious countercyclical
response to recession -- an increase in spending as at the time of the 2008 recession. If everything else remains the
same, an increase in spending would require accommodating a larger fiscal deficit than would have otherwise been
the case. This, the fiscal conservatives argue, is unacceptable, because of the already high level of the fiscal deficit,
placed at 5.8 per cent of GDP in 2011-12. Moreover, influenced by the misplaced view that a higher fiscal deficit
necessarily results in higher inflation, they warn of the dangers of hiking the fiscal deficit in an already inflationary
environment. The government, given its own predilections is inclined to agree. It is also concerned that foreign
investors would disapprove of a higher deficit, turning investor reticence into investor flight.
So increased spending would be acceptable only if it does not setback the governments commitment to significantly
reduce the fiscal deficit to GDP ratio in the near future -- a task made difficult by the slowdown in GDP growth. In
normal circumstances this would mean that the government would have to raise more resources through taxation to
finance spending aimed at reviving the economy. But times have not been normal for some time now because of the
campaign to freeze and reduce direct taxation. Taxes, argue the rich and the corporate sector, create disincentives to
save and invest and must, therefore, be kept to the minimum. The government too seems convinced, possibly with
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The Hindu : Columns / Chandrasekhar : The growth trap

reason, that more taxes on corporate incomes and stock market returns would adversely affect foreign investor
sentiment. So talk of mobilising resources through higher taxation is avoided.
This, of course, leaves the problem at hand unresolved. How should the government respond to the downturn that
threatens to take the economy into a recession? One answer avoids the question by holding that all would be well if
the government is able to continue with reform and even achieve its deficit reduction targets. That argument, if
meaningful at all, must be based on the presumptions that growth is slowing because private investment is down, and
that investment is falling because the slackening of the pace of reform has discouraged private investors. This is
indeed a strange argument because it suggests that while reforms in the past have spurred investment and growth,
that reform, even when not reversed, cannot keep investment going. Only a process of never-ending reform can
consistently drive investment.
Recognising the problem with such an argument, a completely different package is being put forward by a section of
the business community to revive growth without hurting corporate interests. They advocate a step up in public
expenditure, especially investment, to revive demand and growth, but hold that such an increase in expenditure
should not b financed with borrowing or taxation, but by a reduction in subsidies. The strength of that argument
lies in the fact (see Chart) that recent increases in the central fiscal deficit to GDP ratio have been accompanied and
partly explained by increases in the ratio of major subsidies to GDP. So if subsidies can be substantially reduced, it
is asserted, it should be possible to step up investment expenditure without increasing the fiscal deficit.
What is being ignored here is the impact of a reduction in subsidies. In 2011-12, subsidies on food and petroleum
together accounted for 70 per cent of the outlay on major subsidies (on fertiliser, food, petroleum and interest). These
are the subsidies that would have to be reduced if expenditure is to be significantly curtailed. However, neither of
these subsidies are easily cut. Reducing food subsidies is near impossible given the governments commitment to
substantially increase the populations access to subsidised food, with even the diluted Food Security Bill promising to
cover 70 per cent of the population. Going back on that commitment when inflation is high and growth slowing would
be amount to betrayal of a majority that has been left in malnutrition at the margins of subsistence.
Further, in recent times the increase in the subsidy bill has been more on account of petroleum than food, because of
increases in international oil prices. The share of the petroleum subsidies in outlays on major subsidies rose from less
then 6 per cent between 2004-05 and 2008-09 to as much as 34 per cent in 2011-12. So curtailing the subsidy bill
would require a sharp increase in the prices of petroleum products in the manner done recently with petrol. Being
universal intermediates, such an increase in the price of petroleum products would accelerate the current inflation in
the prices of necessities. That would not just be politically suicidal but also detrimental to growth.
The implication is clear. The government would have to find ways of financing an increase in expenditure to counter
the downturn, while addressing with separate policies any impact this may have on inflation or the balance of
payments. But with strong interests working against the choice of such a policy package, there is a real danger that
nothing would be actually done. That would take the economy into the recession that it had managed to stall since the
onset of the global crisis in 2008.
Keywords: GDP growth, Indian economy, inflationary pressure
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