India’s Faltering Economy Could Get Worse and worse day by day

Few economic experts in recent months have been as critical of India’s fiscal policy and governance and as bearish about the country’s economic future if reform does not happen as Rajeev Malik, senior economist with CLSA Asia-Pacific Markets, an independent research and brokerage firm.

Several recent indicators suggest that his bearishness is not misplaced. In November, Mr. Malik warned that India’s currency could fall to 57 rupees to the United States dollar (at the time it was trading at about 52 rupees to the dollar). On Friday afternoon, the rupee was trading dangerously close, at 68.2 to the dollar. In December, he cut India’s economic growth forecast for the fiscal year that began April 1 to 6.3 percent, a forecast that has just recently been echoed by other economists.

Courtesy of CLSA Asia-Pacific MarketsRajeev Malik, senior economist at CLSA Asia-Pacific Markets.

In an interview with India Ink, Mr. Malik discussed Wednesday’s petrol price increase, what the government should do next and what role he thinks  Sonia Gandhi, president of the Congress Party, plays in stifling economic reform in the country.

Q: What are the options available to the central government and the Reserve Bank of India to slow the rupee’s free fall?

A: The ball is very much in the government’s court and with Sonia Gandhi. The R.B.I. is doing whatever it can, and is taking a sensible approach. The last thing it should do is effect a particular level [for the currency] and then defend it at the cost of losing a large amount of foreign reserves. There could be greater pressure in the future on the currency from heightened global aversion, so it would be suicidal to squander reserves.

In all of this, the R.B.I. cannot be the savior. No central bank can be the savior. The Indian government creates the mess and the R.B.I. is the vacuum cleaner, but even a vacuum cleaner can’t do a good job in a garbage dump.

The first thing the government needs to do is wake up and acknowledge there is a problem. Just saying that there are external problems, when almost all of India’s problems are home grown, is not enough. The external issues amplify the domestic imbalances but government’s policies in recent years have significantly worsened those imbalances.

There are many Band-Aid fixes that can be done, but relevant long-lasting benefits require significant hikes in fuel prices to cut subsidies, getting the fiscal and current account deficits under control, improving the local investment climate, squeezing out inflation, attracting foreign direct investment and moving forward with reforms.

Growth is going to be trapped around the 6 percent mark and downside could still be there – it could clearly be lower if nothing is done by the government.

There are no painless options. The can has been kicked down the road so often and for so long, there will be unpopular moves but they have to be undertaken.

Q: Is Wednesday’s steep petrol price increase a sign the government has finally woken up and is ready to make the reforms needed?

A: It is a start, but it only shows a government trying to marginally make up the distance it has fallen behind. It is still wedded to doing the least possible needed to avoid a major systematic problem rather than being pragmatic enough to undertake reforms so that India can do much better. It is merely doing enough for the economy to survive, not thrive.

Q: What’s the next move the government should make after the fuel price increase?

A: We have to see significant increases in diesel and cooking gas prices. The prices of other things, like electricity and coal, have to be closer to market-clearing levels.

The government needs to jump-start investment and create a more enabling environment for growth.

What makes the Indian situation so very unique is that it is not as if the problems are not known or the solutions; it is the implementation that doesn’t happen because of political myopia.

The current dual political structure doesn’t work. It is ironic that the world’s largest democracy has a selected, not popularly elected, prime minister. The people who do understand economics don’t have the political strength to make decisions. Those who have political power either don’t understand economics or are too fixated on populism.

Q: What does a weak rupee actually mean? If it doesn’t have a big impact on most Indian citizens, why should politicians address it?

A: A weak rupee is a symptom of the underlying problem, it is not the problem; it is the messenger rather than the message. It is the outcome of chronically high inflation, policy incoherence and self-inflicted injuries.

Consumer price inflation is over 10 percent, the rupee is in free fall, growth has been crippled and reforms have become a figment of people’s imagination.

The rupee has weakened more since the end of July 2011 than it did during the 1991 devaluation. The significant depreciation now will have a much smaller positive impact than in 1991 because it is not accompanied by a reform agenda. In 1991, the Indian government didn’t have a choice; the International Monetary Fund forced it to put in path-breaking reforms.

Q: What is our worst-case scenario? How low could the rupee go?

A: We don’t know. No one can really forecast currencies very accurately, in the near term and given global uncertainty.

The rupee could easily fall between 57 and 60 to the dollar depending on how the European Union situation plays out. We just have to see what the government ends up doing.

Q: You must speak with government and political advisers. Do you get the sense the central government appreciates the necessity of doing something now?

A: There seems to be a disconnect. The people who understand the gravity of the situation and know what needs to be done don’t have the political capital to push through things. A lot of the relevant people get it; one doesn’t need to be a whiz kid in economics to appreciate what India is going through.

Q: You mentioned Sonia Gandhi earlier – is she the major roadblock standing in the way of the economic reforms that need to happen?

A: It is understandable that she has a political agenda. But strong and well-balanced economic growth will offer more, not less, opportunities for her well-intentioned redistributive agenda. Not undertaking reforms that will boost growth needed to meet the rising aspirations is a one-way path for the government to be out of a job.

I don’t think people are opposed to helping the poor. But the popularity of handouts needs to change. Growth is the best answer to poverty.

We require political will to do something. The more the government waits, the stronger and more unpopular these corrective measures will have to be.

Source : http://india.blogs.nytimes.com