New Round of Reforms Like GST, FDI in Retail, Land Acquisition, Others Can Restore Economic Growth.

India faces a Trifecta: slowdown in GDP growth, high inflation and a weakening rupee. Some of this can be attributed to external factors such as the financial crisis in the western world. China and Brazil are also slowing down. But in the Indian context, we must also look at domestic factors as the main reason for the macroeconomic problems.

Global risk aversion and outflow of funds from emerging markets is affecting countries with weaker fundamentals. As a result, net inflows in India have declined to $0.6 billion during April-October 2011-12 from $27.5 billion in the corresponding period in 2010-11. There can be no doubt that slower growth, high inflation and a weakening rupee are signs of weak fundamentals. They are inter-related and require a coherent and coordinated policy response. The RBI alone cannot be blamed or solve these problems.

The weakening rupee comes as no surprise. If India's inflation is higher than world inflation for a persistent period of time - as has been the case since 2008 - at some point, the rupee must fall to maintain the real exchange rate. The rupee can remain strong only if India continues to attract net foreign inflows in sufficient quantity. If India did not hold large reserves, the panic on the rupee would be even greater. If India had backup arrangements with other central banks - say, by joining the east Asia reserve pool or by having arrangements with major central banks - it could hold fewer reserves. But that is for the future.

The main reason for the lack of confidence is the economic slowdown and the lack of political cohesion to continue with badly-needed reforms to revive it. The recent controversy over foreign direct investment in retail was a clear signal that political deadlock will not allow reforms to go through.

With key reforms in insurance and land acquisition held up in Parliament, the GST stuck in the states and no prospects of any labour reform, it is hard to see how to revive growth prospects. A weakened rupee encourages exports and discourages imports and may be the best hope for some revival, but with balance sheets of major corporates affected by a weaker rupee, the ensuing exchange rate uncertainty will hurt investment.

With a weaker rupee, the fight against inflation becomes more difficult. The pass-through effects of fuel prices and other commodity prices will be felt either on more inflation or a larger fiscal deficit. Inflation was a problem even before the weakening rupee; in fact, the latter is a result of persistently high inflation and not its cause.

A key factor behind inflation is that India has run a very large fiscal deficit and a very loose monetary policy for a long time as part of a stimulus package following the 2008 global financial crisis. This helped prop up growth artificially at over 8% between 2009 and 2011 but led to inflation as supply bottlenecks meant demand outstripped supply.

Subsequently, when the RBI started to reverse its stance and apply the brakes through higher interest rates, the economy started to slow down. The policy uncertainty has also slowed down investment despite considerable liquidity in the market. With rising subsidy payments and a growing wage bill, a greater share of government expenditure now goes to increasing demand, helping fuel inflation.

Mismanagement of the PDS is also a contributor to food inflation with a large share of India's foodgrain reserves destroyed by poor storage and transport bottlenecks. We need a shift to much smarter food reserve management through a better combination of physical storage, advanced purchase agreements in futures markets globally and intelligent use of private stock holding. The new law for FDI in retail would also help in reducing middlemen and handling losses and margins.

How does India get back to growth and low inflation that we saw in the golden period 2002-07? Simply stabilising the economy by cutting expenditure and raising taxes will not solve the problem - although it may avert a crisis. It will take India back to an era of lower growth. The solution has to be a new round of reforms that will restore confidence in the Indian economy and a fiscal compact to bring the deficit down in the next three years through expenditure restructuring and tax reform. The reforms needed are obvious - land acquisition, labour laws, GST, FDI in retail, to name a few, and combined with measures to further reduce red tape, and financial access to SMEs. With these we can be back again on the top table of growth.

India's top leadership knows the answers, now the issue is how to resolve the gridlock in legislating change. If not, people will say India flirted briefly with rapid growth but sank back to the 'Hindu growth rate'.

Source : economictimes.indiatimes.com