Potential Policy Measures to Reignite Growth

There is not much room for further fiscal policy action as the consolidated fiscal deficit of the central and state governments in FY2008–2009 is already approximately 11% of the GDP. The budget for FY2009–2010, presented on 6 July 2009, estimates the fiscal deficit in FY2009–2010 to be at the same level. This implies a significant increase in government borrowing, which has risen from Rs 126,912 crore (US$25.3 billion) in FY2007–2008 to Rs 326,515 crore (US$65.3 billion) in FY2008–2009 and is likely to be Rs 400,996 crore (US$80.1 billion) in FY2009–2010. This also implies a further rise in the debt to GDP ratio, which is expected to go up to 77% and may induce credit rating agencies to review their rating of Indian sovereign debt. Debt servicing, which accounted for about 58% of total revenue receipts in FY2008–2009, is likely to rise even further and pose a significant risk. This large volume of government borrowing is bound to exert a significant upward pressure on market interest rates and also result in inflationary pressures, especially if agriculture output is adversely affected by deficient monsoons. Monetary policy will therefore face tough questions in the coming months. On the one hand it will be trying to hold interest rates down to stimulate private investment demand. On the other hand, it will have to keep a very careful eye on any inflationary tendencies and act quickly to restrain them.

With very limited fiscal maneuverability and the monetary policy constrained by the trade off between holding down interest rates and preventing inflationary tendencies, the focus of policy measures must be to further raise India's potential output growth rate. Various agencies have set the target growth rate between 8.5–9.0%, as shown in the chart below. Raising the potential growth rate requires another round of structural reforms that will improve the investment climate, especially for small and medium enterprises (SMEs) that have suffered the most with the collapse of external demand and employ the majority of the work force. SMEs currently suffer from having to face a plethora of official procedures and licensing and regulatory requirements that raise their transactions costs significantly, making them uncompetitive in global markets and unable to withstand import competition in domestic markets. The government will do well to review all the policies that have an impact on “doing business” in India with the clear objective of improving the investment climate. The evidence for this will be best reflected in an improvement in India's rankings in the World Bank surveys in the coming year.

Figure 20 Potential GDP Growth and Output Gap²⁰ [ PDF 35.6KB | 1 page ]

Other areas for policy attention that will help in removing some of the remaining structural bottlenecks on raising the potential GDP growth rate are the removal of entry barriers for corporate investment in education and vocational training, improving the delivery of public goods and services, and expanding physical infrastructure capacities, including a major effort at improving connectivity in the rural regions. These measures will constitute the second generation of structural reforms and will enable the Indian economy to climb out of the downward phase of the growth cycle and then to extend the upward phase for a longer period than was achieved in the last cycle. The two other areas that require attention and have been often discussed are an urgent improvement in the physical infrastructure and the delivery of public services, specifically urban utilities and law and order. Attention on these reforms will be far more effective and have a more permanent positive impact on raising India's potential rate of growth, which is essential if India is to achieve its goals of poverty reduction and rapid and sustainable growth to improve the overall welfare level of its people.

Download this Paper [ PDF 505.8KB| 33 pages ].

Post a Comment

We welcome your feedback on this publication. Post a comment. ADBI is not obliged to acknowledge or publish comments and may abridge or edit them before web posting.

Comment(s)

There are [0] comment(s) for this entry. Post a comment.