History never quite repeats itself. But there are some disquieting similarities between now and 1997. That was the year when the Asian Financial Crisis struck, the decisions on the Fifth Pay Commission blew a big hole in India’s public finances and political uncertainty ratcheted up. As a result, the growth of investment and exports fell sharply and GDP growth collapsed to 4.3 per cent in 2007/8 from 8 per cent in the previous year. For the six years, 1997/8-2002/3, GDP growth averaged only 5.2 per cent, significantly less than the 6.6 per cent in the preceding five years, 1992/23-1996/7, and much less than the remarkable 8.8 per cent average of 2003/4-2007/8. Are we again on the cusp of several years of slow growth?
Instead of the Asian crisis, we now have a full-blown global financial and economic crisis about which only two things can be said with some certainty: it’s the worst crisis since the 1930s and the end is not yet in sight. The results of the Sixth Pay Commission have certainly added a substantial fiscal burden, though less in relative (to the economy) terms than its predecessor. Political uncertainty has increased, with general elections formally announced and significant prospects for an even more unwieldy coalition government than the one whose term is expiring.
In fact, some things are worse than in 1997. Thus, the combined (centre plus states) fiscal deficit in 2008/9 is likely to be a record-breaking 12 percent of GDP, including the “below the line” items such as oil and fertiliser subsidies which masquerade as bonds. Second, the medium-term outlook for the global economic environment is clearly much worse because this crisis is massively damaging to the industrial country heartland of the global economy, not just to its Asian “periphery”, as in 1997. Third, the social stress and dislocation from the present growth slowdown could be greater than a decade ago since the deceleration follows a period of exceptionally high growth and rising expectations for jobs and incomes that it spawned.
On the other hand, a few things are better than in 1997. The Indian corporate sector is in much better shape, with five years of extraordinary growth and profits under its belt and, on the whole, good balance sheets. Second, the level of aggregate savings and investment in the economy is much higher, officially estimated at 38 and 39 per cent of GDP, respectively in 2007/8. By the first half of 2008/9 the investment rate had only dropped to 37 percent of GDP, although data for the second half, once available, is likely to show steeper falls. Both government and corporate savings are likely to take a significant hit. Third, monetary policy has reacted (loosened) more swiftly than in the 1990s downturn.
Looking ahead, my two biggest sources of concern about the medium-term outlook would be the weakness of the fiscal situation and the enormous uncertainty about the depth and duration of the ongoing global economic crisis. It is worth reminding ourselves that five years of successful fiscal consolidation had brought the combined fiscal deficit (inclusive of off-budget items) down to 5.6 per cent of GDP in 2007/8. In one single year, 2008/9, the deficit has more than doubled to about 12 per cent of GDP. It is also worth recalling that the bulk of the deterioration was due to massive subsidies for oil products, fertilisers and food and deliberate under-budgeting for government pay increases, the farm loan waiver and sharply higher expenditures on the national rural employment guarantee programme. The three “fiscal stimuli” of December, January and February contributed only modestly to the startling fiscal deterioration.
Against this background it is not easy to justify the post-interim-budget announcements of late February, which extended the earlier 4 percentage point cut in the general excise duty (announced as a temporary measure in December) and the made further 2 percentage point cuts in both excise duties and the services tax rate. Taken together, they amount to a widening of the projected fiscal deficit for 2009/10 by about one percent of GDP.
Coupled to the widespread belief that the interim budget projections for tax revenue are highly optimistic, we can be reasonably sure that the combined fiscal deficit in 2009/10 will exceed 10 per cent of GDP, even absent a rebound in the international prices of government-price-controlled commodities. In the context of slumping export demand, this may sound fine. But we need to remember that this entails net central government market borrowing of over Rs. 350,000 crores in 2009/10 (over triple the level in 2007/8) and market borrowing by state governments in the order of another Rs. 100,000 crores or more. In comparison, net financial savings of households is unlikely to be much above Rs 600,000 crore and the increase in aggregate bank deposits is likely to be of a similar order. In other words, there are real prospects for higher interest rates on government bonds and hence of higher long term interest rates for the private sector. In the last two months the 10-year government bond rate has already risen by 1.5 per cent. We may be returning to a situation where a “stimulated” fiscal policy drives interest rates higher, to the detriment of private investment.
The global economic situation continues to worsen. Despite trillions of dollars of stimulus and bail-outs in the US, 4.4 million jobs have already been shed in this recession and the unemployment rate climbed above 8 per cent last week. The financial meltdown continues. Last week the insurance giant AIG reported a quarterly loss of $62 billion, which is larger than the value added by India’s entire banking sector in a full year! The Japanese economy shrank at an annual rate of 13 per cent in the last quarter of 2008 and its exports plummeted by 46 per cent in January. European GDP is expected to fall by 3 per cent in 2009. Few expect any global turnaround in 2009. And even after that the recovery, whenever it comes, is like to be slow and halting. In short, we are unlikely to see global economic growth at 3 per cent or higher for perhaps three-four years. Nobody really knows.
Against this background, India’s 5.3 per cent growth in the October-December quarter looks satisfactory. Full year growth in 2008/9 is likely to be 6 - 6.5 per cent (not the 7.1 per cent claimed by CSO a month back and still voiced by some government spokesmen). For 2009/10, I still hold to my Christmas expectation of 4-6 per cent (BS, December 25). Given the huge uncertainties prevailing, it would take a braver man than me to project beyond that. The only sure bet is that we can bid farewell to the 11th Plan expectations of 9-10 percent economic growth in the coming three years.
The author is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. Views expressed are personal