The gap between commentary and performance could hardly be starker. As the UPA government enters its middle period, the absence of political support for economic reform has been widely noted. Bimal Jalan and Pratap Bhanu Mehta have both offered articles to this effect in the pages of the Financial Times. The same sentiment was also the burden of a recent leader and cover story in The Economist, and has been a consistent theme of many leaders and opinion pieces, including the writings of Surjit Bhalla, Shankar Acharya and T N Ninan, editor of Business Standard.
The economy refuses to take notice. This is clear on a perusal of the Mid-Term Review 2005-06 of Macroeconomic and Monetary Developments put out by the Reserve Bank of India on October 25. Published concurrently with the semi-annual monetary policy review by Governor Reddy, this marvellous publication keeps improving in scope, conciseness, currency and presentation.
The good news is perhaps well-known, but bears retelling. Real GDP growth for the fiscal's first quarter is 8.1 per cent, including 10.1 per cent for industry and 9.6 per cent for services. Within industry, manufacturing is on a tear, growing at 11.3 per cent. Merchandise export growth has been strong: up 25 per cent from April to August in US dollar terms, and broad-based both in commodity composition and in destination market.
Perhaps even more important for the health of the economy has been the continued buoyant growth of non-oil imports (29 per cent in the fiscal till September), within which capital goods imports have grown even faster. As the Review notes, the return to a trade deficit has assisted the job of liquidity management, allowing the RBI to dispense with the market stabilisation scheme and to use its more conventional tools of open market operations.
Forward-looking variables, namely the various business sentiment surveys, the stock market and indicators of investment performance are all buoyant. Even the news on the fiscal front is relatively encouraging, although even more could be demanded given the strength of the economy.
The most important indicator of our ability to avoid a debt trap is the consolidated primary deficit of the central government and the states. (The primary deficit represents the gross fiscal deficit less interest payments. Improvements in this ratio indicate that interest payments are at least partially being met from current revenues, rather than exclusively through fresh borrowing.)
The projected outcome this year is of a primary deficit of 1.7 per cent of GDP, roughly half the figure of four years ago. Importantly, progress is being made both at the Centre and in the states.
Of course, more needs to be done: with the fiscal deficit for the current year projected at 7.7 per cent, the implied interest burden on the public finances is 6 per cent of GDP. This is a significant source of inflexibility in the Budget and crowds out productive recurrent expenditures. But if fast growth continues and the framework of the Fiscal Responsibility and Budget Management Act is honoured, this ratio should come down in due course.
What lies behind this good news?
Clearly, international developments have been very important. Stimulative fiscal and monetary policies, particularly in the US and Japan, the two largest industrial countries, have touched off a global boom.
But India has been much better prepared to seize these opportunities than in the past, because of its greater integration with the world economy, both through trade and through finance.
On the trade side, I do not think it is coincidental that the investment revival has occurred only after we resumed the process of reducing industrial tariffs in the last couple of budgets.
As is the case with proposals to liberalise FDI in the retail sector today, we were warned that the Indian consumer goods industry would be devastated if liberal trade were permitted, and only removed quantitative restrictions on such imports after an adverse judgment by a WTO tribunal. Yet, even with the process still incomplete, and India remaining one of the most heavily protected economies in the world, we find our manufacturing sector flourishing.
While the benefits of trade reform are perhaps well recognised by scholars, the benefits of financial integration remain more controversial. Yet it seems difficult to deny the benefits of such integration in the Indian case when we see the improvement in corporate governance that has been established through the modernisation of our equity markets. The role of foreign institutional investors in this process has been critical. As the MTR points out, the integration between domestic and international money markets is also proceeding apace, admittedly shielded by some remaining capital controls.
Greater international integration has therefore been enormously beneficial for the Indian economy. Yet, agreeably, we still enjoy a relatively balanced economy when compared with several of our Asian neighbours.
In particular, demand is better distributed between domestic and foreign sources, and between consumption and investment. Indeed at a conference in China at the end of last month, the governor of the Chinese central bank indicated that stimulating domestic consumer demand is one of their major challenges. This is also an issue for both Japan and Korea.
Complementing our external reforms have been the reforms in our tax system. These too are only partially complete, but they have been in train long enough to have made a difference. The adoption of a state-level value-added tax is another step on this journey, although again there is a long way to go before we reach the desired national goods and services tax. But the direction is clear, and, as with trade policy, seems to enjoy bipartisan consensus.
While the above sounds complacent, it is not meant to be. Instead, my argument is that getting a few big things right has generated large returns. Since we are only part of the way both in openness and tax reform there is every reason to stay the course. But backsliding in either area could equally be highly damaging.
There is a further area that needs to be pursued, which is redefining the role of the state in economic management. As we have seen, the present compulsions of coalition policies make this a difficult area to pursue at present. But the debate must be continued. Were we to achieve a similar national consensus in this third critical area, India truly could amaze the world.
