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Mainstream, VOL LII No 29, July 12, 2014

Seven Key Economic Challenges before the New Government

Monday 14 July 2014

by Vinay K. Srivastava

The results of the 2014 Lok Sabha elections have come out and the BJP-led NDA has come to power under the leadership of Narendra Modi. I take this opportunity to congratulate him for this tremendous win and wish for continued success in all his future endeavours.

The new Prime Minister inherits an economy in crisis. India’s GDP growth is the lowest in a decade, inflation is high, industrial growth has frozen and job growth has dried up. Meanwhile, infrastructure development has slowed and the fiscal deficit hangs like the Damocles’ Sword. The BJP promised fiscal discipline and banking reforms among other policy-plans when it announced its election manifesto.

Narendra Modi is expecting to make the economy, and specifically job creation an urgent focus of his government. A push for infrastructure projects is also expected. The railways are likely to get special attention.

Here are seven key economic challenges towards which the new government’s attention should be directed.

1. Gross Domestic Product

The GDP growth is a measure to prove that the economy is growing and the country is making progress. The average GDP growth during the late Narsimha Rao’s government, NDA rule, and UPA-1 was 5.2 per cent, six per cent and 8.4 per cent respectively.

During UPA-2, the average growth rate was 6.7 per cent. The economic growth rate in the current financial year has been estimated at 4.9 per cent, the pace being faster than in the previous year. The growth in the GDP during 2013-14 is estimated at 4.9 per cent as compared to the growth rate of 4.5 per cent in 2012-13 (CSO). The CSO had lowered the growth for 2012-13 to 4.5 per cent in its revised estimates from an earlier provisional forecast of five per cent.

For 2013-14, the CSO has projected a growth rate of 4.6 per cent in agriculture and allied sectors, up from 1.4 per cent a year earlier. Manufacturing, however, is expected to register a contraction of 0.2 per cent in this financial year compared to the growth of 1.1 per cent in the previous year.

Asia’s third largest economy is battling the worst slowdown since the 1980s as the GDP growth has almost halved to under five per cent in the past two years. Accelerating the GDP growth will be the biggest challenge for the new government.

2. Inflation

The second challenge that the new government will face is high inflation in the economy which erodes the real income of the people. During the last fifty years the average inflation rate has been seven to eight per cent annually. The problem has got aggravated in the last five years 2008-12 when the inflation averaged 10.36 per cent (CPI). Thus in five years, the value of the rupee has got depreciated to 50 paisa.

Huge wasteful public spending and budgetary deficits are largely responsible for inflation in our country. In developed countries, which manage their economies sensibly, the average annual inflation rate over a long period of time has remained within a range of one to two per cent. Wholesale prices in April rose slower-than-expected by 5.20 per cent, as a nearly 18 per cent drop in onion prices since March slowed down food inflation to 8.64 per cent from 9.90 per cent in March. However, the prices of such vegetables have since then increased phenomenally.

3. Current Account Balance

Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid). This page provides—India Current Account—actual values, historical data, forecast, chart, statistics, economic calendar and news.

The Reserve Bank has expressed grave worries about the current account deficit (CAD). This hit a record 4.2 per cent and 4.7 per cent of the GDP in 2011-12 and 2012-13 respectively. The country recorded a current account deficit of US $ 4.20 billion in the fourth quarter of 2013. Current Account in India averaged US $ -1.63 billion from 1949 until 2013, reaching an all-time high of US $ 7.36 billion in the first quarter of 2004 and a record low of US $ -31.86 billion in the fourth quarter of 2012. P. Chidambaram recently said the CAD was brought down significantly to $ 32 billion in 2013-14 as against $ 88 billion during 2012-13 and fiscal deficit contained within the target in the last fiscal. The CAD in 2012-13 was at 4.7 per cent of the GDP and in 2013-14 it is expecting to be 1.7 per cent.

A sharp narrowing in the current account deficit was helped by steps to curb gold imports. Higher duties and other restrictions almost halved gold imports but the moves have been deeply unpopular with Indian households who invest in the yellow metal to protect their savings from inflation and to provide gifts at weddings and on other special occasions. Gold smuggling is also suspected to have surged after the measures, casting doubt on the reported data. The BJP has promised to review gold import duties within three months of its coming to power.

4. FDI

Despite policy paralysis and a poor investment climate, India received large inflows of both FDI and foreign portfolio inflows in 2012. Notwithstanding bad publicity from the alleged mistreatment of Vodafone and Wal-Mart, FDI inflows actually shot up by 34.4 per cent but it barely grew in the fiscal year that ended in March as delays in clearances and funding issues grounded many infrastructure projects. FII inflows are typically far more volatile than FDI. However, despite the eurozone crisis and recent slowdown in the US, FII inflows into India exceeded $ 10 billion in January-July 2012.

The BJP promised in its manifestoto to cut red tape and encourage foreign investment in sectors needed for job and asset creation. But it said it was opposed to foreign investment in multi-brand retail. Any review of FDI in multi-national brand retail will probably have to wait.

5. Fiscal Deficit

The fiscal deficitis running between five to six per cent of the GDPof the government for the last five years which is totally unsustainable and may land the country in a debt trap. There is an urgent need to reduce the crippling burden of debt and restore the fiscal balance.

To achieve a revised fiscal deficit target of 4.6 per cent of the GDP for the year ended in March, the Congress-led government cut spending by $ 13 billion and pushed about $ 16 billion in subsidy costs into the New Year.

6. Foreign Exchange 

India suffers from a huge trade imbalance and over the years, exports have been able to finance the import bill only to the extent of 60 to 75 per cent. In recent years the position of trade deficit has worsened. During 2012-13, while exports were $ 301 billion, imports were $ 501 billion, with the trade deficit of $ 200 billion—exports meeting only 60 per cent of the import bill. Heavy imports on account of petroleum—$ 155 billion, and gold—$ 60 billion, have contributed to the worsening trade deficit.

In the past, a measure of stability in the foreign exchange front had been provided by IT earnings and NRI remittances (IT earnings $ 62 billion and NRI remittances $ 65 billion in 2012-13). Serious efforts are required to boost exports and reduce imports and bring a measure of stability on the foreign exchange front. A huge trade imbalance implies that we are exporting jobs abroad, and are unable to create a competitive economy and employment opportunities in the country.

7. Disinvestment

Public Enterprises played a catalytic role as an engine of growth in India. In the early stages of development, when capital was scarce and industrialists shy from entering into industries with long gestation periods and huge capital investment, the public enterprises got their basic rationale and extension more than the total industrial investment, regardless of cost and returns. However, later on, the PEs performed poorly and become deep swamps of inefficiency. They were taken to be the ‘white elephants’. This paved the way for disinvestment in the new industrial policy. This policy clearly laid emphasis on their disinvestment. Later, the NDA Government followed this policy and pushed the process of disinvestment more vigorously. However, the target of disinvestment could be achieved only during 1991-2013.

The UPA-1 Government had declared that no profit-making PEs will be disinvested. The Ministry of Disinvestment has also been closed down. It appears that the process of disinvestment will be slowed down. The policy of the UPA-2 Government on disinvestment envisaged developing people’s ownership of Central Public Sector Enterprises to share in their wealth and prosperity while ensuring that the government equity does not fall below 51 per cent and retains management control.

In an interview Modi said that he is not in favour of privatisation. He says disinvestment is a word that will be used with care. Thus, he should outline what alternative strategies he has in mind to revive the PSUs whose deteriorating finances have become a drag on Central resources.

An economic revival, however, depends on the new government’s success in controlling inflation and reviving capital investments, which probably grew at their slowest pace in 11 years in the fiscal year that ended in March. Thus, this requires reforms to improve governance that reduce waste in government programmes and improve the space for private innovation and enterprise.

All such measures will improve productivity. This is the best way to improve the health of the economy.

Dr Vinay K. Srivastava is an Associate Professor and a Visiting Faculty of IILM-AHL, Greater Noida, Dr K. N. Modi University, Newai, Tonk, Rajasthan and Mewar University, Gangrar, Chittorgarh, Rajasthan. He is an approved Ph.D. supervisor of Mahamaya Technical University, Noida. He is also the Managing Editor of Arash, a journal of the ISMDR, and Honorary Secretary of the Indian Society for Management Development and Research. (ISMDR)