The stagnation hypothesis
13 July 2012
Unpacking claims of a ‘crisis’ in the Indian economy.
Many economists, policy makers and commentators – both from the Right and the Left – and especially representatives of corporate capital, have characterised the current conjuncture as a crisis of the Indian economy. While different analysts offer different policy prescriptions, the first question to ask is whether the facts justify this characterisation? So let us start with the facts. Measured by growth of GDP , the Indian economy has been slowing since the fourth quarter of 2010-11, when GDP growth was 9.17 percent. That figure has declined steadily to 5.33 percent according to the latest available data from the fourth quarter of 2011-12. Inflation rates have remained stubbornly high, with the headline wholesale price index (WPI) inflation hovering around 7.6 percent and the consumer price index (CPI) inflation climbing back into the double digits to stand at 10.4 percent in April 2012. While WPI inflation measures increases in wholesale prices in the economy, CPI inflation is more relevant for common people as it tracks increases in retail prices – the prices at which we buy commodities in the market. Double digit CPI inflation is very worrying because it quickly erodes the purchasing power of consumers. The combination of economic slowdown (which some economists characterise as stagnation) and high inflation has even led some commentators to diagnose a case of ‘stagflation’ – a scenario first observed in the advanced capitalist countries in the late 1970s.
As the argument goes, the evils of a stagflationary trap are compounded by the twin deficit – the Indian government’s budget deficit and current account deficit – and the depreciating rupee. India’s current account deficit – the disparity between expenditures on imports and earnings from exports of both goods and services (after accounting for the net outflow of dividends and other income payments) – has increased spectacularly over the last few years, from around USD 9.66 billion in 2006-07 to USD 78.2 billion in 2011-12. The Indian government’s budget deficit – the gap between government expenditure and revenue – spiked at about 10 percent of GDP in 2009-10, but has since gradually declined to about 8.7 percent of GDP in 2011-12. The rupee’s nominal exchange rate vis-à-vis the US dollar (the rupee price of a USD) has increased by about 20 percent over the 2011-12 fiscal year, reaching an unprecedented high of INR 56 per US dollar by May 2012.
Does this combination of problems – slower economic growth, persistent high inflation, widening current account and government budget deficits, and a sliding rupee – constitute a crisis of the Indian economy? The answer is ‘no’. The portrayal of the current scenario as a crisis has more to do with the push for policy changes by domestic and foreign private capital keen to complete the process of ‘economic reforms’. The most vociferous proponents of the crisis hypothesis are also the most ardent champions of more reforms. This includes international institutions like the International Monetary Fund and the World Bank, representatives of Indian corporate capital like the Federation of Indian Chambers of Commerce and Industry, giants of the international business press such as the Wall Street Journal, theEconomist, and the Financial Times, and their Indian counterparts such as the Economic Times.Questioning the crisisIf distributed fairly, the slower economic growth would be more beneficial than blistering growth that benefits only a small segment of society. For more equitable growth to be achieved, of course, the current combination of problems requires careful handling and a decisive course change in India’s economic policies.
The current slowdown of growth, while real, cannot be realistically characterised as economic stagnation. Both in absolute terms and compared to most countries in the world, India’s growth rate remains high. It is certainly higher than recent growth rates in neighbouring Southasian countries like Bangladesh, Pakistan and Nepal (although Sri Lanka has been growing faster than India over the last two years). Moreover, investment and saving rates, both key drivers of long-run economic growth, remain high by historical standards, as can be seen in Figure 1.
The debate regarding inflation is more complicated. Both WPI and CPI inflation in India is among the highest observed in the developing world in recent months (Pakistan and Venezuela are among the very few countries with higher CPI inflation than India). India’s current bout of inflation is driven by increasing food and fuel prices. Food price inflation, in turn, owes to worldwide increases in the prices of vegetables and protein sources due to reduced production and supply in developing economies like India. Meanwhile, the government’s claim that domestic fuel price inflation is the result of similar global price increases is only partially true. International crude oil prices have remained relatively stable over the past year even as India has increased the price of fuel in keeping with policy decisions. While other factors such as the depreciating rupee do contribute, India’s fuel inflation is largely a matter of government policy.
The fact that high inflation persists in the face of a slowdown in economic growth suggests that India’s inflation has more to do with supply constraints than with demand pressures. The corresponding slowdown in the advanced capitalist economies, China, Brazil, and other parts of the world should reduce the price of crude oil, which should then help ease inflationary pressures. In India, a lot also depends on the current monsoon: if the rains are good, food production and supplies could increase substantially, also helping to reduce inflation. While inflation is certainly high, India’s growth rate is nowhere as low as it would be in a truly stagnant economy.
Turning to the external sector, one fact has been repeatedly highlighted in the mainstream press: India’s current account deficit has been increasing over the past few years. From USD 9.66 billion in 2006-07, it has risen steadily in subsequent years and stands at USD 78.2 billion in 2011-12. While this continuous increase is potentially worrying, India’s current accumulation of foreign reserves still provides a comfortable safety cushion. At USD 286 billion as of May 2012, the quantity of reserves is adequate for financing India’s current pattern of foreign trade for more than three years. Therefore, the chances of a balance-of-payments crisis like the ones witnessed in 1991 or 1965 are quite low, unless India witnesses a massive net outflow of foreign capital (something like that observed during the 1997 East Asian crisis).
So what do we know about net capital inflows into the developing countries? According to the World Bank, net private-capital inflows to developing countries will fall to $775 billion this year, compared to $1.06 trillion in 2010. This slowdown is a result of the on-going problems in the Eurozone and the faltering recovery in the USA. While this will adversely affect reserve build-up in all developing countries, there is nothing peculiar to the Indian economy that is driving this phenomenon in the country. The World Bank also points to a possible positive development in the near future. Due to continuing fiscal problems and loose monetary policies in the advanced capitalist countries, capital inflows to developing countries are expected to pick up by next year. Hence, there are no indications so far that India will face a severe balance-of-payments crisis anytime soon.
While India’s short- and medium-term prospects look robust, it is also necessary to recognise that a long-term policy that is overly dependent on capital inflows to balance the country’s external accounts is a dangerous mistake. It makes the policies of the country subservient to the whims and fancies of global finance and erodes sovereignty. Other than during the 1970s, India has run a trade deficit for most of the years since 1947, but has relied on the inflow of foreign capital to bridge that gap between export earnings and import expenses. The alternative course of action would be to consistently boost export earnings to cover the import needs of the economy. Promoting labour-intensive industrialization and reorienting Indian exports to serve middle- and low-income economies can facilitate that alternative, and so help the Indian economy to end its dependence on foreign capital.The fall of the rupeeAnd what of the free-falling Indian rupee? India’s nominal exchange rate against the US dollar has been increasing since the early 1980s, as can be seen in Figure 2; the current increase in the exchange rate is part of this long-term pattern. That pattern has been interrupted substantially only twice – first, during much of the 2000s, from the end of the US recession in 2001 up to the global financial crisis in 2007; and second, rather more briefly, for two-and-a-half years beginning March 2009. The exchange rate resumed its long-term upward trend in July 2011 and reached a high of INR 56 by early April 2012. Long-term changes in the exchange rate are determined by the relative rates of inflation in the two relevant economies. Thus, controlling the rupee’s fall against the dollar in the long run will require controlling inflation in India.
The depreciating rupee also has significant short-term impacts. On one hand, it makes the Indian economy more competitive, and could potentially boost its exports and improve the trade balance. In the current scenario, though, that prospect seems to have been stifled by stagnation in the Eurozone economies. On the other hand, a depreciating rupee further drives inflation through higher rupee prices of imported products, most notably oil. Clearly then, a depreciating rupee has contradictory short-run effects, and might not be the unmitigated disaster that many commentators claim it is. Still, in the current context, exports have not been rising, and depreciation has had a largely negative effect in terms of feeding inflationary expectations. To address the problem of inflation, which is largely driven by supply constraints, the government needs to step up its investment in the agricultural and infrastructural sectors.
Turning to the Indian government’s budget, the situation is, once again, nowhere near as bad as the mainstream business press often claims. It is true that the government’s deficit climbed to 7.19 percent of GDP in 2008-09, and even further to 9.8 percent of GDP in 2009-10, largely due to stimulus spending meant to counteract the slowdown. But this expenditure was absolutely necessary to boost domestic demand while private spending slumped in the wake of the global crisis. Since 2009, the deficit has gradually come down to 8.7 percent of GDP in 2010-11. The primary deficit – the deficit excluding interest payments on existing loans – also climbed down from 5.1 percent of GDP in 2008-09 to 4.4 percent of GDP in 2010-11. Overall, recent changes in the government deficit are perfectly understandable, and their levels are certainly within manageable limits.
To summarise – though the Indian economy has slowed down over the last five quarters, economic growth remains high both in relative and in absolute terms. Inflation remains high, but global economic stagnation and a good monsoon could ease price pressures in the near future. Meanwhile, despite the growing current account deficit, India’s foreign reserves provide a sufficiently large cushion against unexpected shocks in the near future. The government deficit is also at a manageable level, and has in fact been slowly shrinking. On the whole, talk of a general crisis in the Indian economy seems rather far-fetched. The only pressing issue is the high inflation that is battering the common people, especially those at the very bottom of the economy – mostly agricultural labourers and informal sector workers – who have no mechanisms (such as effective collective bargaining arrangements) that can ensure that their income growth keeps pace with inflation. The steady erosion of these people’s purchasing power also hampers long-term growth as it shrinks the domestic market.PrescriptionsWhy, then, all the hullabaloo about the crisis of the Indian economy? The answer lies in political economy. Changes in the relative power of corporate capital within India’s ruling coalition since the mid-1980s have significantly changed Indian economic policy. That change was accelerated in the early 1990s under the pretext of a balance-of-payments crisis. These ‘economic reforms’ liberalised the rules governing private capital, especially those relating to trade and investment. These measures went hand in hand with the privatisation of some public enterprises, massive reductions in public support for agriculture, and the State’s gradual retreat from providing education, health care, social security, and other welfare measures for the poor.
However, due to resistance from numerous peoples’ movements and repeated electoral verdicts against these ‘economic reforms’, several key elements of the reform package have not been implemented yet. These include, but are not limited to, liberalising the financial sector, easing the flow of foreign capital into and out of the country, privatising infrastructure such as ports, roads, and railways, withdrawing fuel, fertiliser and food subsidies, and allowing the entry of foreign capital into India’s massive retail sector.
One interesting argument in the arsenal of pro-reform analysts is the so-called ‘policy paralysis’ that has left the Indian government incapable of enacting major economic policies. If proponents of this claim are to be believed, the gross government incompetence evident in numerous recent corruption scandals – such as the 2G spectrum scam and the 2010 Commonwealth Games scam – are symptoms of the paralysis. This line of thinking subsequently blames the slowdown on the ills of the current political system. The irony, though, is that such major corruption scandals result from corporate manipulation of government policies. Loosening the rules on corporate capital and reducing the government’s regulatory functions – both of which are key components of current calls for economic reform – will increase, and not decrease, such corruption scandals.
And so we have a broad consensus emerging (or rather, being assiduously fashioned) in favour of accelerating the economic reforms. From the reports of the International Monetary Fund and the Federation of Indian Chambers of Commerce and Industry, to the pages of the Economist, the Wall Street Journal, and the Financial Times, the same argument is doing the rounds: reversing the current slowdown requires ‘structural reforms’ – an euphemism for adopting some or all of the policies listed above – rather than further stimulus spending.
While advocates of these reforms would have us believe that their approach offers the only solution to the current ‘crisis’, there is in fact plenty of room for India to opt for another path. In particular, the Indian Left should use the combination of macroeconomic problems facing the Indian economy – which are very much real – to argue for an alternative policy mix ultimately tethered to a socialist vision of economic growth and development. While the long-term vision rests on empowering the working class as a politico-economic entity vis-à-vis capital, the short- and medium-run policy mix should promote agricultural growth, massively enhance public education, health care and other welfare measures, increase public investment in basic infrastructure such as safe drinking water, public housing, sanitation, roads, electricity, and public transportation, and pro-actively pursue rapid, labour-intensive industrialisation in rural India. It is important to emphasise that this alternative policy mix would address all the problems that the Indian economy currently faces.
Public investment in agriculture is crucial as, by increasing the incomes of the 55 percent of the Indian workforce currently engaged in the sector, agricultural growth can create the domestic demand necessary to revive investment and industrial production, which would encourage much more sustainable and broad-based economic growth across the country. This is especially important since much of the global economy seems headed for stagnation in the near future, meaning that external demand will, at best, remain weak. Improved economic growth would, in turn, increase government revenue and so reduce the budget deficit. Also, by increasing food production, agricultural growth can ease the supply constraints that underlie India’s current inflationary cycle (recall that inflation in India is driven less by demand factors than by supply bottlenecks).
Raising public investment in basic infrastructure and services would also contribute to this process by easing crucial supply bottlenecks. Since the long-term decline of the rupee vis-à-vis the US dollar is related to the relatively higher inflation in the Indian economy, agricultural growth and public infrastructural investment would automatically address the exchange rate issue by reducing inflationary pressures. Further, improved public education and health care would aid labour-intensive rural industrialisation by increasing the skill base of the Indian workforce. This could then make India more competitive internationally, increase its export earnings, and address the long-term trade imbalance of the economy.
On a broader scale, this alternative policy vision should vigorously attack the growth fetish that is currently in vogue. After two decades of blistering growth, the vast majority of the Indian workforce still labours in the informal sector, which is marred by extremely low wages, hazardous working conditions, and minimal or no labour rights. More than half of Indian households still lack latrines. Malnutrition is worse in India than in Sub-Saharan Africa, with a third of the world’s malnourished children living in India. If these are the results of the current growth model, then serious questions must be asked about the nature of such growth. It is necessary to highlight that growth and distribution must go together; one cannot be viewed in isolation from the other. The current conjuncture certainly calls for a discussion on how to revive economic growth, but it also obliges us to bring issues of income and wealth distribution back into the debate. It is not obvious that the pro-capital measures preferred by mainstream economists and commentators would lead to higher economic growth, but even if the alternative policy mix outlined above leads to slower growth, it would lead to much faster improvement in the living standards of the vast majority of Indians. If for nothing else, for that reason alone it should be preferable.
~ Deepankar Basu teaches economics at the University of Massachusetts, Amherst. His research interests include political economy and development. He would like to thank Debarshi Das for his help with this article.