India’s Slowdown May Have a Silver Lining
IMF Blog, May 24, 2012
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- Authors: Roberto Guimares, Laura Papi
- Published: May 24, 2012
Recent slowdown: facts and near-term projection
- Authors and date: Roberto Guimarães, Laura Papi; May 24, 2012.
- Context: Global financial crisis of 2008-2009 and ongoing international financial market volatility, high and volatile oil prices, and the uneven global recovery.
- GDP growth dynamics:
- GDP growth fell throughout 2011, from a high of 7.8 percent at the beginning of the year to 6.1 percent in the quarter ending in December.
- The slowdown in the economy has affected the industrial sector particularly hard and extended to 2012 as shown by the 3.5 percent contraction (y/y) in March industrial production.
- IMF projection for 2012/13: GDP growth is likely to be about 7 percent.
- Perception: By international standards 7 percent growth is still very robust, but it contrasts with rates above 9 percent a few years earlier.
Investment: magnitude, drivers, and long-term implications
- Magnitude and pattern:
- Investment reached 38 percent of GDP in 2007/08, just before the onset of the global financial crisis, lifting growth to nearly 10 percent.
- Investment growth subsequently dropped sharply, crossing into negative territory for the last two quarters of 2011.
- This downturn is unprecedented: with the exception of the September-December quarter of 2008, one would have to go back to the last quarter of 2001 to find a year in which investment fell. Since quarterly national accounts have been compiled, no consecutive declines in investment were recorded until 2011.
- Drivers:
- Weakness in investment has been mainly due to domestic factors, such as high and volatile inflation, but not real interest rates.
- Macro variables alone cannot fully explain the weakness; structural factors affecting the business environment were also at play.
- Long-term implications:
- Investment is a component of aggregate demand; its decline must be offset elsewhere to maintain a given growth rate.
- Lower investment translates into lower productive capacity and lower average growth over time.
- Rule of thumb cited: a one percent of GDP decline in investment could lower trend growth by about 0.3 percent.
- The decline of share of investment in GDP by 3.7 percentage points since the global financial crisis could lower trend growth by slightly more than one percentage point.
- Long-run income effect: income per capita would be nearly US$1,000 lower in 20 years (more than 50 percent of today’s income per capita) if the economy were to settle at a growth rate of 7 percent instead of 8 percent.
Supply constraints and structural bottlenecks
- Binding constraints and consequences:
- Supply constraints particular in power, mining and land have become increasingly binding.
- These constraints have raised costs and inflation, damaging investor sentiment.
- Structural reforms and areas of focus:
- Streamlining taxation through the Goods and Services Tax (GST).
- Facilitating business investment via additional financial reforms, especially for the corporate bond market.
- Facilitating trade and easing labor regulations to boost productivity and job creation.
- Education improvements to raise skills and employability.
- Fiscal consolidation and reforms to increase resiliency and make growth more inclusive.
- Reducing inflation in a durable way as the best contribution the Reserve Bank of India (RBI) could make to rapid and sustainable growth.
Policy steps, recent measures, and the potential silver lining
- Immediate government actions to boost investor sentiment:
- Accelerate the pace of project approvals.
- Launch high-impact reform initiatives such as rationalizing fuel subsidies and further liberalization of foreign direct investment rules.
- Priority sectors and measures:
- Addressing problems in the power and coal sector as an immediate priority due to cross-sectoral linkages.
- Latest budget measures begin this process with some financial reforms, measures to broaden the use of public-private partnerships (PPPs), and an enhanced role for UDIs (unique identification numbers) in targeting government programs to improve spending efficiency.
- Financial sector and monetary policy actions:
- The RBI has continued to implement financial reforms to facilitate infrastructure financing, improve the transmission of monetary policy, and promote financial inclusion.
- Outlook:
- If positive signs are quickly followed by bolder government action, the recent slowdown could have a silver lining by catalyzing reforms and restoring investor sentiment.
Source: India’s Slowdown May Have a Silver Lining, Roberto Guimarães and Laura Papi, May 24, 2012.