Dec 6, 2024 04:20 IST
First published: December 6, 2024 at 04:20 IST
Failure has many fathers. RBI Governor Shaktikanta Das projected a growth rate of 7 percent even though most of the current macroeconomic data for the second quarter of the financial year were available. The actual estimate came in at 5.4 percent. What economic miscalculation made this big mistake, and what does it mean for India’s march towards a developed India 2047? On the last question, not much now. Growth rates are not cast in stone, long-term or otherwise. For most economists, macro growth rates are a function of policy – if it were all a random walk, economists and other policymakers would be redundant. Policy may not affect results in the very short term, but certainly in some quarters. What is a competitive exchange rate difference? Can Tariffs Affect Growth? Can MSPs with import controls affect food inflation? We could go on and on but you get the drift – policies affect outcomes.
Over the past two years we have been confident that India’s path towards high-income country status by 2047 is reasonably possible. With India’s long-term GDP growth averaging just 6.1 percent, many others felt it was a pipe dream of 23 years. These experts now claim that they are not surprised that GDP growth has fallen to nearly 3 percentage points from a peak of more than 8 percent five quarters ago. We’re not surprised either. As recently as the IEG-Finance Ministry Kautilya Economic Conference in September, we flagged the potential derailment of the Indian growth story due to two mega road-blocks – high rates of taxation and tax collection, and a rapid decline in foreign investment. On a short-term basis, the level of real interest rates also makes a difference, with potential consequences for mid-term health.
Given that the RBI gives its decision on policy rates today, let’s discuss the actual policy rates first. There are two issues that merit discussion: Should the RBI look at actual policy rates based on core inflation or headline inflation? However, India has been running an unnecessarily tight monetary policy for two years post-Covid. The average real repo rate for core inflation in non-advanced economies is 1.2 percent, for India it is 2 percent. The median real repo rate for headline inflation in non-advanced economies is 0.9 percent, for India it is 1.4 percent. During the much-discussed growth success story of 2004-2011, the real policy rate was minus 1 percent. It is well accepted that India has had a contractionary monetary policy for the past eight quarters and in the process, the MPC has slowed the economy much more than they had anticipated.
In 2023, the ratio of all tax revenues (centre, state, local) to GDP will reach 19 percent. Most critics of the developed India dream point to the fact that we lag behind our competitors in East Asia with abnormally high import tariffs that harm our competitiveness, efficiency and growth. Yet they turn a blind eye to the low all-tax revenue rates of 17 percent in East Asia, 16 percent in China, and 13 percent in Vietnam. It goes without saying that tax revenue grows with GDP and the per capita income of East Asia is much higher than that of India.
Incorrect assessments often result in incorrect policy calls. An example of such policies would be foreign direct investment. It is recognized by all development organizations that these two components are critical to the Viksit path – infrastructure investment and FDI. The importance of both is readily apparent. In the East, full marks to two big-infrastructure-enthusiastic prime ministers – Atal Bihari Vajpayee and Narendra Modi. In the latter, withdrawal from Bilateral Investment Treaties (BITs) was a significant flaw in the judgment of policy makers. Given the sharp decline in foreign investment, there is ample evidence for an urgent reconsideration of this matter. Foreign investors are less likely to invest in the unpredictability of contract enforcement, timely resolution of conflicts, and judicial principles and actions. Investors will look for the best place to park their funds and withdrawing from BITs increases foreign investor risk without increasing returns. Slower growth in the coming years could also lead to a re-examination of returns dampening investor sentiment, both domestic and foreign.
Economic Survey 2024 India wants to play a third role in China’s infrastructure BRI (Belt and Road Initiative) monopoly and we should invite and welcome Chinese foreign investment. Still, this survey is indifferent if not in tune with India’s misguided policy of “restricting” BITs. Another unresolved issue is retroactive changes in tax policies such as the removal of indexation benefits on real estate assets. The specter of retroactive taxation haunts India’s economic prospects. This problem was supposed to be solved by imposing legal restrictions on such changes, but all three branches of government routinely make retroactive changes against the spirit of improving the “ease of life.”
Recent policy changes such as retroactive tax changes, restrictions on certain types of spending through credit cards and withdrawals from BITs are signs of a gradual reversion to a command-and-control type of economy. The state – or empire – wants to strike back, defying the prime minister’s repeated advice to limit the role of the state in the lives of citizens.
The sooner we rid ourselves of the remaining shackles of Nehruvian socialism that continue to influence statist impulses within government, the sooner we can avoid making policy mistakes that undermine our prospects for development. There is a deep gap between the Prime Minister’s vision of limiting the role of the state and bureaucracy and the reality of Nehruvian impulses in current policies.
Many countries have lost the momentum of development by taking good growth as their right. No country can achieve a growth rate of 6 or 7 percent. India’s growth challenge is partly driven by the large disparity between its per capita income level and the overall size of its economy. Institutions and policy-making are expected to lead the way to a developed India, the world’s fourth largest economy soon, but we still have to contend with the policies and norms of an economy with a per capita income of less than $3,000. . We want to be a developed economy; We must start working on our ambitions.
Bhalla is a former executive director of the IMF and Bhasin is a New York-based economist. Views are personal