Growing pains

Clarify policy and ease bottlenecks to spur investment

Preventing India's growth slowdown is a difficult but not impossible task. The government needs to follow a two-pronged strategy to put India back on a high-growth path. On the one hand, it must focus on putting stalled projects back on track. On the other hand, it must put in place policy frameworks for the allocation of land and natural resources, as well as for environmental standards and the rule of law.

Episodes like the 2G spectrum sale and the coal block allocation issue demonstrate that the lack of a clear framework can seriously disrupt investment and growth. Though there are no easy answers to these questions, arriving at policy frameworks through research, public consultation and discussions among stakeholders, and implementing the rule of law, should make them more tractable than they are today.

One somewhat simple way to address growth slowdown in the short run may be through fiscal and monetary policies. But in India, macroeconomic policy choices, even in the short run, are going to be very difficult. The latest data on output and prices confirm the stagflation that has been on its way. We now see growth slipping below 5 per cent, even as consumer price inflation reaches 9.75 per cent. This is almost the reverse combination of what India witnessed a few years ago at the peak of the business cycle.

As output growth slipped in September 2012, with the IIP data showing an actual contraction in economic activity, consumer price inflation continued to rise, hitting almost double digits. The trade data released also showed a higher trade deficit. Stagflation is a much more difficult problem than overheating, which happens when prices and output are both rising, and which we saw in 2006 and 2007. That is when fiscal and monetary policy both need to be contractionary. Tackling stagflation is also more difficult than facing a recession, when fiscal and monetary policies both need to be expansionary. When faced with stagflation, no standard recipes work. Contractionary fiscal policy would mean raising tax rates, something that would hurt investment further. Easing monetary policy would mean cutting interest rates, something that would make inflation worse. The experience of other countries like the US, which has seen stagflation in the past, suggests that simple solutions can only worsen economic conditions.

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