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Don't blame the world

Domestic policy is primarily responsible for macroeconomic problems

Shankar Acharya 

Shankar Acharya

Over the past two or three years, as India's economic performance has deteriorated badly, it has become commonplace to hear senior members of the government attribute most, if not all, of the worsening in economic performance to external factors. Typically, these have included the slow and uncertain recoveries from the global financial crisis in the US and Japan and the lingering crisis and recession in Europe. Let me agree straightaway that these are very real problems that have beset the global economy in recent years. Let me also agree that the implications of these global frailties have been clearly negative for India's development potential. Where I part company with government spokesmen is in the relative weight attached to external and domestic factors in explaining India's weakened performance, especially in regard to the sharp slowdown in economic growth and the ratcheting up of external deficits.

Thus, and speaking heuristically, if government apologists assign perhaps 70 per cent-plus of the country's poor economic performance to external causes and the remainder to domestic policy problems, I think it might be more accurate to reverse these relative weights, with domestic policy weaknesses shouldering most of the blame. To give an example, if the potential growth rate of the Indian economy was 9-10 per cent in the pre-global-crisis world, it may now be down to 7-8 per cent because of the weak global environment. But that surely does not explain the collapse of GDP growth to barely five per cent. For that we have to invoke failures in domestic economic policy. (Click for charts)

Aside from asserting a different point of view, what can one do to buttress one's case? One obvious answer is to look at the performance of other Asian developing countries like India. There is, of course, the difficulty of finding comparator nations "like India". A likely candidate is China, with its 1.35 billion inhabitants and significant developing country characteristics despite her explosive growth in the last three and a half decades. A glance at the graph shows that China's economic growth has also slowed in the last two years, but much less sharply than India's. Moreover, in the other three dimensions of macroeconomic performance, China has done rather well and far better than India. Inflation has been low (around 3-5 per cent), compared to near-double digits in India. A large part of the reason could be China's much stronger record in maintaining fiscal balance, with deficits running below three per cent of GDP, instead of the profligate 8-9 per cent of GDP level that has become the Indian norm after 2007-08.

Furthermore, despite having an economy much more open to international trade and capital flows than India and, therefore, potentially more vulnerable to global economic setbacks, China has managed to retain a comfortable surplus in its current account, running at 2.5-3 per cent of GDP in the last two years. And this is not because China's international trade has collapsed in the wake of the global crisis. In 2012 China's goods exports exceeded $2 trillion, nearly 70 per cent higher than in 2007 and almost seven times the level of India's 2012-13 exports!

Some will cavil "you can't compare us to China; they are an eight trillion dollar economy, more developed than developing, and besides, they have a disciplined, authoritarian system of government, which makes them special". This counter carries little conviction in the present context of trying to identify the relative roles of external and domestic factors in explaining India's steep decline in economic performance. Never mind, let's move on to the next largest developing country in Asia, namely Indonesia. With a population of 245 million, this nation is an order of magnitude less populous than India and China. On the other hand, in respect of socio-political system and stage of economic development, Indonesia bears significant similarities to India. And the size of her economy is about half India's, not small by any means.

A notable feature of Indonesia's recent macroeconomic performance is the steadiness of her economic growth in the last three years, a little above six per cent each year. There is no hint of a slowdown, despite her openness to foreign trade and capital flows being at least as much as India's. Inflation too has been moderate at around five per cent a year, a "comfortable" level not seen in India during the last six years. Indonesia's moderate inflation levels may well be linked to her even more moderate fiscal deficits of less than two per cent of GDP in each of the last four years. The contrast with India's massive fiscal deficits is striking. Like China, Indonesia has also run surpluses on her external current account for most of the period, except for 2012. Taken together, the picture is one of responsible macroeconomic management, yielding good steady progress on the major indicators.

To sum up, our economic performance in the last three years has been markedly worse than that of China and Indonesia. Since all three countries engage with the same world economy, it is hard to make the case that global economic problems have hit India disproportionately hard. The much more plausible explanation for our unusually weak macroeconomic performance is surely the mismanagement of our own economic policies. Let us stop blaming the world.

The writer is Honorary Professor at Icrier and former Chief Economic Adviser to the Government of India.

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First Published: Wed, April 10 2013. 21:50 IST