In the last Economic Survey I did, in 2008-09, my main concern was overconfidence.
What I warned then was that when growth rises, everyone thinks of how it can be stepped up. It is not like that. Countries always go to a higher level. But there is always a danger of falling off. Only 2-10% countries which go to higher level of growth are able to sustain it.
In the paper which I had done three years ago, I had shown that percentage has gone down to zero. I define high level growth as average growth of 10 years. A few decades ago, the highest went up to 33-37%. A third of the countries were able to sustain high growth. In the latest decade, it has gone down to zero.
In 2007-08, when growth rate had gone to 7-8%, everyone was saying let us go to 10%. I argued against it in the government and outside it. The fact that we were able to pull out of 2008 crisis, people began to have exaggerated confidence.
The beginning of the problem is the false confidence and illusion that we could keep going faster and faster if we did the right things. What I said is that we have to do the right things to sustain it, not to grow faster. I don’t see anything like it in history. There are always fluctuations. The good ones manage the fluctuation. Most of them get knocked off. That’s what has happened.
Why was this illusion sustained?
One of the things was the fiscal illusion. You can always create a bubble. 2010-2011 is an example of that. The growth rate was 9%-plus. That was an indicator. The fiscal deficit, etc were showing bubble characteristics. But there is nothing on public record to show that anyone recognised it.
The other warning signal is current account deficit. The conventional wisdom used to be 2.5%. It shot up to over 4%. I don’t know what happened. The current prime minister used to be very afraid if the current account deficit went up to 2.5%.
The third warning signal is what we call the real effective exchange rate. The rupee was appreciating all these years. That was a classic case of a danger signal.
The actual crisis happened, I remember very well, in August 2008.
I was the chief economic advisor to the finance minister. The RBI governor and all were in Washington. On the flight, when we got back here, the whole world had collapsed. The money supply graph showed a cliff. Everyone was doing fiscal stimulus. The US was doing it. China was doing it.
Here, everyone, economists and bureaucrats were saying that there is no fiscal space for a stimulus.
I said we need a fiscal stimulus. I said that farmers’ loan waiver was a good thing in retrospect, though as an economist, I feel that was not the right way of helping farmers. We need to give more stimulus. I had to also convince investment analysts, whose money was on the line. I also said that when the growth was back to 8%, and it did in 2009-10, the stimulus should be wound down.
That didn’t happen. The stimulus was through increased expenditure, tax deductions and automatic stabilisers like decline in revenue collection. I recommended that the tax deductions should be removed once the growth was back. It was not done.
The basics of the economy are much worse than in 1991, but we are much better to deal with it because of all the reforms we have done. If you look at the current account deficit, the debt factor is important. The net indebtedness has deteriorated by 50% in two years. In 1991, market economy did not exist. We have a flexible exchange rate. There are structural reforms on the anvil. They are lying in parliament. These are the strengths. But strengths do not matter if we do not use them.
What needs to be done? Three or four things. One is called the macro-pivot. That is, expenditure reduction, expenditure switching strategy. That basically involves reduction in the consumption expenditure of the government. It can be direct expenditure, it can be subsidies or a combination of the two. An example is oil price reforms.
Tightening the monetary policy is the worse thing to do right now because it is going to impede growth. In the current situation, we have to let the exchange rate be set by the market. The underlying problem is competitiveness. We allowed the rupee to appreciate to tackle the capital inflows. That affected the competitiveness of the rupee.
The third thing is, we have to do structural reforms for competitiveness. Why is there no investment? Because the economy is not competitive. Advertently, or inadvertently, we have done things which reduced the competitiveness. Unless competitiveness is restored, all other measures are cosmetic.
Where is the problem? It is infrastructure. Dismantle all monopolies. There are monopolies in coal, in railways, in ports. Electricity Act has not been accomplished in distribution segment.
A Cabinet decision has to be taken that monopolies in infrastructure will be dismantled. And you must take those six steps to do that. You do not have to dismantle immediately. If you do this, in six months, the situation will be completely different.
If there is a euro crisis, that would be a strong enough trigger for a crisis at home. There is improvement in the European and American economies. But that gives you only the breathing time. It does not mean that things will get sorted out on their own, without us doing anything.
(As told to Parsa Venkateshwar Rao Jr)