Riddle of the 5.3 per cent
What has made matters worse is that India has not even enjoyed the "benefit" of lower inflation from falling growth. Instead, inflation has remained stubbornly high. The authorities and many in the market have raised this as a puzzle. But there isn't one. India's growth has fallen from 9 per cent to 5 per cent not because of slowing consumption but because corporate investment has declined sharply. When corporate investment falls, it has an insidious impact: it lowers the productive capacity of the economy. While demand has slowed, growth in capacity has been slower, so that despite the lower growth, there is little excess capacity in the economy. Consequently, inflation has remained high. Add to that the hardened inflationary expectation, which, as per the RBI's own survey, is around 13 per cent today.
But all is not lost. The new economic policy team in Delhi, through its September reform blitz, has changed investor sentiment, although in recent weeks it too has fallen silent. It now appears that the government will survive the opposition's onslaught against FDI in multibrand retail. Hopefully, the cabinet will approve the proposed National Investment Board that could potentially restart the investment cycle. The implementation of direct cash transfers holds out the hope of lowering the subsidy bill markedly and allaying a key concern of rating agencies.
But these measures are unlikely to put the economy back on a sustained high-growth path. India today needs deep second-generation reforms that change the institutions that govern the economy. In the heady days of 2003-08, when India grew at 9 per cent, we did not pay much attention to these institutions. Indeed, the jury was still out on the first-generation reforms of the 1980s and 1990s, as growth hadn't done anything remarkable till then. And then the 2008 global crisis occurred. In the face of rising uncertainty and slowing global growth, India's investment and GDP growth dropped sharply. Rather than rallying support for second-generation reforms, loose monetary and fiscal policies were used as easy options. An intractable political situation was bandied as the reason. But under the pressure of falling global growth, the inadequacy of the first-generation reforms became evident and India's institutional weaknesses came to the fore.