Too little growth is bad? Too much of it may be worse

The International Monetary Fund (IMF) is saying that European economies must focus on growth as prolonged recession will lead them on the path from which they cannot come out. In the same breath, IMF is also saying that debt-ridden countries should focus on fiscal consolidation without which they cannot grow.

The IMF statements are like bitter pills to the citizens of Greece, Spain, Portugal, Ireland and Italy, where budget cuts are causing rising unemployment rates, especially among the youth, and have changed the way of life for many.

IMF is known for its bitter pills. The aid conditions for Greece were so stringent that there was no way that the country could have growth. Asian economies will remember the IMF forever as they were treated like scum for mismanaging their economies.

India too tasted the IMF bitter pill when it went through a tough phase in the 1990s after running out of foreign exchange reserves. In short, no one likes the IMF especially countries that have to go to the institution with begging bowls.

So the IMF is saying focus on growth. How can one ask? The debt-ridden European governments cannot increase spending as it will then increase public debt and that is a no -no to both the European Central Bank as well as Germany, which effectively controls the euro zone. The weak economy is deterring private investments. Exports are slowing as world economy is slowing. IMF has revised downwards the global growth forecast for 2012 from 3.5% to 3.3%. China’s third quarter GDP came in at 7.4%, a three-year low on account of global growth slowdown.

The only way out for countries to grow is by receiving aid from the IMF, which as everyone knows comes with such stringent conditions that makes growth almost impossible.

A perfect Catch-22.
India is also facing a similar Catch-22 situation where higher growth is a problem and lower growth is also a problem. India’s GDP is expected to grow at 4.9% for 2012-13, as per the IMF. The IMF growth forecast for India is the most pessimistic of the lot with every other agency, except the RBI and the government (at 6.5% levels), forecasting growth for the country in a 5.5% to 6% range.
India’s fiscal deficit is expected at around 5.3% of GDP and above for 2012-13 against budgeted levels of 5.1% of GDP. India cannot spend more and increase the fiscal deficit as it will take up inflation, which at 7.8% for September 2012 is the highest for calendar 2012. Higher fiscal deficit will also take up government bond yields, leading to rising cost of borrowing in the economy. India is grappling with high inflation, high interest rates and a slowing economy.

However, pulling up growth is a difficult task and the government has to come up with path-breaking reforms on subsidies and foreign direct investments to push growth higher.

The government has realised this and has come out with some reforms of allowing higher FDI in a few protected sectors such as retail, insurance, pension and aviation. Higher capital flows bring in the much needed capital for investments in the country and also protect the currency that is suffering from a fall due to a high current account deficit, which stood at 3.9% of GDP for the first quarter of 2012-13.

India cannot afford not to grow at a high rate as it then increases unemployment, raises poverty levels and creates socio-economic problems.

Slower growth also leads to lower tax revenues and higher fiscal deficits, which again are detrimental to interest rates and inflation.
 The current issues of corruption scams and crony capitalism are also holding the country back from a growth path.

So what will drive growth forward for the European economies as well as the Indian economy? Will it be the US economy, which seems to be the best positioned of the lot despite its debt issues? US economy is being helped by the Fed, which is pumping in money into the system to reduce mortgage rates and to bring down unemployment rate.

The behaviour of the US equity markets, which are the best performing markets globally over the last one year and the strength of the US dollar, which is up against major currencies over the last one year, do suggest that the US economy is best positioned for growth. A stronger US economy can pull up the world economy, benefiting countries like India.

On their own, countries facing slow growth and high debt will find it difficult to break the Catch-22 situation they are in now.
Arjun Parthasarathy is editor of www.investorsareidiots.com,
a website for investors