INDIA’S ECONOMIC SLOWDOWN

HOW SHOULD INDIA AVERT THE COMING SLOWDOWN

Chetan Ahya

The Economic Times, June 27, 2011

After the credit crisis , India (like many other developed and emerging economies) resorted to fiscal and monetary stimulus to push growth back to pre-crisis trend immediately. This was a justified policy action at the worst point of the crisis, but we believe the policy-makers overstayed the course.

The government maintained high expenditure growth (a large part of it tends to be revenue spending in nature) and the Reserve Bank of India ( RBI )) also left real policy rates in negative territory for a long period. While this easy approach did boost growth strongly, the low productivity dynamic accompanying it meant that the country faced challenges of inflation, current account deficit and tight inter-bank liquidity.

The most challenging symptom for the policy-makers has been inflation. Indeed, we believe that a large part of the food inflation is because of this low productivity dynamic of government spending in the rural India and less due to structural shift in protein consumption.

Structural shift cannot justify a cumulative rise of 55% in primary food inflation since January 2008.

However, a policy-induced growth slowdown now appears inevitable. A combination of factors - including persistent high inflation rate, higher oil prices, sharp rise in interest rates, and a weak global capital market environment - is likely to result in slowdown in growth. We have already cut our FY 2012 (year-end March 2012) GDP growth forecast to 7.7% and have highlighted further potential downside risks to GDP growth of about 50 bps.

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