During 2014 India's prospects have improved somewhat. Inflation is declining steeply, fiscal and external imbalances are lower, and India appears to be in a better position to handle global volatility. While much remains to be done, sentiment about India has changed, reforms are on the anvil and the macro situation has been stabilised. The platform for transformation is being laid.
With inflation declining more rapidly than was anticipated - due to declining global commodity prices - the focus must shift to accelerating growth. Increasing the growth rate to the six per cent-plus in 2015 that the finance minister is predicting should not be that difficult. India's incremental capital output ratio (ICOR), which measures the return on capital invested, has risen sharply from around four in the period 2004-2009 to over six in the last five years. Reducing the ICOR to around five by quicker decision-making to complete projects, and better coordination among ministries and PSUs to improve capacity itself would do this without even an increase in India's investment rate. But India needs to raise itself to a much higher eight per cent-plus growth path. For this, reducing the ICOR is not enough; the overall investment rate must rise - with an increase in both public and private investment.
In the medium term, a good GST will help raise the tax intake as it helps widen the tax base. But, as international experience shows, this takes three to four years. What to do in the interim? How to raise public investment without compromising the fisc is the key question that must confront the finance minister. We don't need more PSU investment - that is a path towards uncompetitive growth. One solution is to put in place a much more ambitious disinvestment programme with the revenues raised earmarked for public goods investment. With lower international fuel prices a special levy to finance an accelerated transport investment programme would be another option. Finally, special infrastructure bonds could be raised for smart cities and the power sector. All these options should be on the front burner.
For reviving private investment the PM's "Make in India" campaign has the right ring to it. With India's manufactured exports forming less than 1.5 per cent of global manufactured exports India could easily expect to double its global share if it were to become more competitive. China's share is over 15 per cent of global manufactured exports - some ten times India's share. So the room for growth in exports even in a sluggish global market remains huge. India does not need to choose between producing for the domestic market or for exports. Competitive industries - such as car parts, motorcycles, engineering goods, gems and jewellery - produce for both the export and domestic markets. Make for India is a subset of Make in India, not a substitute for it.
Much of what is needed for a successful "Make in India" lies in more competitiveness through structural and micro reforms - factor market reforms, better infrastructure and ease of doing business. This will bring in the FDI and domestic private investment for a major growth push like we saw in the 1990s. The GST that the finance minister is spearheading will also stabilise our finances and create a larger domestic market more attractive for foreign and domestic investors.
But India also does need to rethink its exchange rate and macroeconomic policy for a successful "Make in India" campaign. India has always erred on the side of a more overvalued rupee. The RBI's latest calculations of movements in the real exchange rate using the new CPI index show that the rupee was seriously overvalued by over 20 per cent between July 2009 and July 2013. It was during this period that the economy slowed sharply, the CAD rose alarmingly and eventually the rupee corrected sharply, first overshooting to almost Rs 70 to the dollar but eventually settling around Rs 60. Since then the rupee again appreciated in real terms as domestic inflation remained well above world inflation. The rupee is once again correcting to more realistic levels of Rs 64-65 to the dollar.
For a "Make in India" campaign India needs more FDI and less FII. The latter helps keep the rupee high, hurts exports and encourages imports. India has been obsessed with a strong-rupee policy as if it signifies a strong economy. The East Asian countries - especially China - have instead followed for a long time a policy of keeping their currencies undervalued by anywhere from 10-30 per cent. A strong rupee is also seen as necessary for lower inflation. But as we have seen, inflation has much more to do with commodity cycles, food policy and high fiscal deficits - not the exchange rate. There remains however a strong corporate, banking and importer lobby for a "strong" not a weaker rupee. This will have to change to make our macro policy consistent with the structural and micro reforms for Make in India.
The new body that the PM promised on August 15 on the ramparts of the Red Fort to replace the dead-end Planning Commission must now be brought out to take such campaigns and reforms forward. Why not call it a National Transformation Commission to signal the many transformations India needs over the next decade and a half to help reap our demographic dividend and emerge as the globe's third largest economy by 2030? Let us lay the foundations for that in 2015.
The writer is a visiting scholar at the Elliott School of International Affairs, George Washington University