Growth sans 'big bang' reforms

India's economic resilience shows incremental reforms are more effective

The Indian economy’s recovery after the Covid shock of 2020-21 has been remarkable. Who would have thought India’s gross domestic product (GDP) growth would exceed 7 per cent thereafter for three consecutive years? There is now the prospect of achieving a 7 per cent growth in 2024-25 as well. 

 The growth of 9 per cent in 2021-22 is understandable.  It represents a bouncing back from the decline in GDP in the previous year. The surprise is the growth rates of 7 per cent in the next two years. These growth rates, remember, have happened under adverse international conditions.

In both 2022-23 and 2023-24, India was faced with the Ukraine conflict and high interest rates in the advanced economies. The fallout of these was a deceleration in global growth. For much of this period, inflation in India too remained at an uncomfortably high level and required monetary tightening.

In November 2022, many analysts warned that we faced exchange rate and balance of payments challenges similar to those of 2013. Some analysts saw the exchange rate of the rupee plummeting to below Rs 85 to the dollar. They advised the government to put in place measures to deal with any contingency that might arise.

None of this came to pass. The Indian economy has seen off the challenges of the past two years with aplomb. The finance ministry’s review of the Indian economy ascribes the economy’s resilience to the policies pursued during and before the Covid shock.

That is true, but one must recognise that the external shocks have not been as severe as feared. The Ukraine conflict did not quite lead on to an oil shock and a significant derailment of the global economy, as many had forecast. The US and its European allies chose to impose a price cap on Russian oil supplies, instead of an outright ban on these. This had the effect of making oil available at a reasonable price to buyers while limiting the revenues accruing to Russia.

The government’s response to the Covid shock, as the review notes, was distinctive. In comparison with the fiscal stimulus in other economies, India’s stimulus was modest and contained a large component of capital expenditure, not transfers for consumption. Localised lockdowns and nationwide vaccination helped contain infections.

Regulatory forbearance in banking has contributed significantly to the positive outcomes. Such forbearance is frowned upon as merely “kicking the can down the road”. The Reserve Bank of India showed that regulatory forbearance, if practised imaginatively, can be effective. The banking sector, which was under stress even before the Covid shock, saw a reduction in the gross non-performing assets to 3.2 per cent of outstanding loans in September 2023. This is an outstanding achievement. 

Over years of dealing with natural disasters, such as flood and earthquake, India has developed considerable expertise in disaster management. Repeated bouts of economic stress have contributed to a similar expertise in dealing with economic disaster. Policymakers now have a set of effective toolkits at their disposal for dealing with balance of payments, banking and financial markets crises.

Economists and analysts had insisted that growth would be stuck at 6 per cent or below without serious reforms. One imperative for higher growth was said to be fiscal consolidation. We are far removed from the mandated objective of a 3 per cent fiscal deficit as a percentage of GDP and 60 per cent for public debt. 

“Big bang” reforms — privatisation, greater freedom to hire and fire, overhaul of land acquisition rules, among others — have been conspicuously absent. Judicial and administrative reforms are also areas where progress has lagged behind aspiration. And yet, neither the lack of fiscal consolidation nor the absence of “big bang” reforms has come in the way of three years of growth of 7 per cent-plus.

Many analysts will say that the present growth momentum largely represents a rise from the low base of the Covid period and cannot be sustained. The finance ministry’s review does not seem to think so. It suggests that growth could rise above 7 per cent after 2030 but gives no indication that this requires “big bang” reforms.

Instead, the review indicates that such an outcome would ensue from less drastic reforms that are already happening: Investment in physical and digital infrastructure; improved balance sheets at both corporations and banks; technology transfers through growing foreign direct investment; investment in human capital; and an improved investment climate.

A possible counter would be that serious reforms could take growth to an even higher level, say, 8 per cent. This is wishful thinking. It is hard to see the fiscal deficit dropping below 5 per cent in the near future. India’s growing economic clout will require a matching increase in its military capabilities. This means defence expenditure alone could add 1 percentage point to the fiscal deficit. The phasing out of fossil fuels and investments required to meet climate change commitments could add another percentage point to the fiscal deficit. The fact that India has produced a respectable growth rate despite high fiscal deficits and public debt reduces the incentives for politicians to conform strictly to the Fiscal Responsibility and Budget Management Act, 2003.

As for “big bang” reforms, a parliamentary majority, we have seen, is not a sufficient condition for these reforms to happen. Successive governments have understood that reforms must be consistent not just with macroeconomic stability but also with political and financial sector stability, and considerations of national sovereignty.

“Big bang” reforms remain politically contentious; we are about to witness another siege of the capital by farmers who had earlier succeeded in getting farm laws repealed. Achieving faster GDP growth requires a pace of bank credit growth that can be destabilising for the banking system. Greater openness to reforms may lead to faster growth but every nation is now more careful about what and how much it is importing from whom.

Whichever way you look at it, sustained growth of 7 per cent seems to be the optimal outcome for India. The record of the past three decades suggests that this can happen with incremental, not “big bang”, reforms.

ttrammohan28@gmail.com