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India in a three-speed world

The economy may be performing better than the euro zone, Japan and the US, but it can do even better if it continues to bring reforms

Anoop Singh 

Anoop Singh

The news on the global economy has been mixed. While some countries are doing well, others are beginning to slow and policy makers around the world are concerned about the risks of a three-speed world. The first speed is one that is too slow: while confidence has improved in the euro zone, and Japan has initiated a new round of stimulative policies, growth in both areas remains low for the time being. The second is one that remains slow, but is accelerating, as we see in the US, where "fiscal cliff" risks have receded, but unemployment remains high. And finally, in many emerging markets and low-income countries, growth is relatively high.

The latter category includes many countries in Asia. Indeed, as described in our recently issued Asia-Pacific Regional Economic Outlook, the International Monetary Fund expects Asia to grow 5.7 per cent in 2013, while the world as a whole grows 3.3 per cent ( The prospects for emerging Asia are even higher at over seven per cent in 2013. In most countries in the region, the gross domestic product (GDP) has risen close to trend levels and risks to the outlook for the region appear more balanced than was the case at the time of our October 2012 update. In addition, as Figure 1 suggests, for many countries inflationary pressures remain muted.

Asia's policy makers, nevertheless, face a delicate balancing act in the near term: guarding against a build-up of financial imbalances and managing a transition to rebuilding policy space, while delivering appropriate support for growth. Against the backdrop of uncertain growth prospects, many Asian central banks in 2012 maintained their already-low policy rates or reduced them further. With inflation remaining low and stable, this accommodative stance has been welcome. But financial imbalances are often persistent and cannot be easily unwound and output levels are close to or slightly above trend in most economies; hence, monetary policy makers should stand ready to respond early and decisively to any prospective risks of overheating.

Policy makers, thus, need to keep a close eye on the credit cycle and potential financial imbalances: one lesson of the global financial crisis is that once problems begin to appear in banks and across the rest of the financial system, they can be extremely costly to unwind. Fortunately, policy makers in East and Southeast Asia are increasingly making use of macro-prudential tools to keep property markets under control and ensure that capital inflows, partly triggered by monetary conditions in advanced economies, do not cause domestic markets to overheat. Rebuilding policy buffers is essential, too. Budget deficits in many Asian countries are higher now than before the crisis. Bringing budgets closer to balance will help create space for governments to react to future shocks, but the pace will depend on how strong each country's underlying growth prospects are.

India's situation differs somewhat from that of many large East Asian economies. Growth slowed to only four per cent in 2012 - down from double-digits in 2010. At the same time, even with the recent decline, wholesale price index inflation remains at six per cent, with consumer price index inflation even higher at over 10 per cent. This combination of slowing growth and still-high inflation would be challenging enough, but at the same time, India's current account deficit in 2012Q4 widened to over six per cent of GDP. High inflation and the continuing strength of imports (even non-gold, non-fuel imports) suggest that the economy has little spare capacity, and that there is only limited scope for activist monetary policy to spur growth. On the fiscal side, the government has shown - through expenditure control, higher diesel prices, and the strong 2012-13 Budget out-turn - that it is strongly committed to fiscal consolidation. But the task is not yet complete, as Figure 2 suggests. On a cyclically adjusted basis, India's overall (central plus state level) fiscal deficit is still high. Extending the ongoing work on subsidy reform will require allowing for market pricing of LPG, diesel and fertiliser while ensuring that the poor are protected. This will help the government bring down the deficit while reorienting spending toward key social and investment goals. But, in the meantime, the implications are that cyclical policies have limited scope for supporting growth in India.

Instead, the way forward lies in building further on the government's structural agenda on investment. As the prime minister said in a speech to the Confederation of Indian Industry in early April, "In a private sector led economy... the driver of growth is indeed private investment. But the private sector needs an environment in which enterprise can flourish and create both jobs and stimulate growth." The new Cabinet Committee on Investment, created to accelerate projects in coal, roads and mining, is already accelerating the domestic investment process. The ongoing liberalisation of the foreign direct investment regime can be followed up by working with potential foreign investors to assist them in investing in India. Sorting out the difficulties of the electricity sector, including appropriate pricing of imported and domestic coal, loss-recovery pricing by state electricity boards, and a more predictable environment for electricity generators, will improve sentiment and facilitate investment. Progress has been made in all these areas, and this augurs well for its future potential.

On the legislative front, passage and implementation of the Goods and Services Tax is widely regarded as helping build overall efficiency in the Indian economy. It will make it easier for companies to take advantage of scale economies, while bringing the country more closely together as a common market. Simplifying the process of land acquisition to make it transparent for buyers and fair to sellers will also help support investment, particularly in infrastructure but also in housing and manufacturing. And liberalising India's labour regulation, making it easier and more profitable for companies to hire more workers, will create more formal-sector jobs.

Compared to the first two speeds in today's three-speed world, India is doing well. But by continuing to implement reforms, India can do even better.

The writer is Director, Asia Pacific Department, International Monetary Fund

First Published: Mon, May 06 2013. 21:44 IST