Expert Zone

Straight from the Specialists

The year the Indian economy stalled

December 17, 2012

(Any opinions expressed here are those of the author, and not those of Thomson Reuters)

The year 2012 has seen the worst an emerging market economy can tolerate. Had the government been a little less reticent and more proactive, growth would not have dropped this low in spite of the economy being mauled by inflation. Other emerging market economies did exactly that.

The year had started well. In January, inflation had eased and the Sensex had gained 11.5 percent, raising hopes of an upswing. But some adverse factors proved more enduring and the budget only added to the gloom that followed. Some factors were beyond our control; others were politically difficult or conceptually faulty.

We could do nothing about the adverse economic conditions in Europe, the United States and Japan which had caused the sharp drop in our exports after January when they peaked at $25 billion. That had an impact on industrial growth, which also weakened due to diversion of consumer purchasing power to the agricultural sector.

Industry was worst hit. Since March, growth turned negative with the capital goods sector underperforming the most because of the fall in corporate investment following high rates of interest and paralysis in governance. The Reserve Bank of India (RBI), with its strong orthodoxy, ensured that interest rates were well above the rate of inflation though some out-of-the-box policies could have eased inflation and saved growth as well.

The stock market was more optimistic than industry. But for the two unreasonable fiscal devices — General Anti-Avoidance Rules (GAAR) and retrospective taxation — introduced in Budget 2012-13, FII inflows would have been sustained and the rupee prevented from depreciating too fast. Fortunately, the situation was partly retrieved by the Shome committee.

The government, which had given in to political blackmail by the Trinamool, finally sensed the inevitability of reforms and took the risk to announce a slew of measures, including foreign investment in multi-brand retail. With the Trinamool out of the coalition, the government had to have support from the Samajwadi Party and Bahujan Samaj Party to carry forward its agenda. The winter session of parliament will possibly be historic since it broke a three-year stalemate in economic reforms and won political friends for the Congress. This will ease the way for pending bills on banking, insurance or pension funds.

But the economy had to bear the stress caused by political hesitation. GDP growth, which was at over 9 percent, had dropped to 8.4 percent in 2010-11. Since then, it went downhill to 5.3 percent in July-September quarter. That appears to be the floor laid out by the fast expanding services sector, mainly in finance and commerce, and sets the stage for recovery.

Expectations are that recovery should begin in the first quarter of 2013. Even the RBI governor who had displayed indifference to growth appears to have changed his mind. A cut in interest rates along with the reforms that have been adopted and will be introduced should get the economy back to growth.

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