Indian economy stuck in maze

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In 2013-14, GDP growth is expected to recover from last year’s lows. The recovery however, critically hinges on normal monsoons, which would lift consumption growth. If the monsoons fail and agricultural GDP does not grow,  the overall GDP growth may not improve much over the last year.
Over a longer horizon, a sustained economic recovery will depend on how we tackle the ‘DIRE’ risks the economy faces. At 5 per cent, India’s GDP growth touched decadal lows in 2012-13, charting an inverted ‘U’ over the past decade. Ten years earlier, growth was at four per cent. In between, it averaged 8.3 per cent peaking at 9.6 per cent in 2006-07. So, how do we reverse this and how long will it take before the recovery?
Over the last two years, the inverted U has taken a firm hold on the Indian economy. In 2012-13, manufacturing output grew by merely one per cent, following a 4.4 per cent growth in 2011-12.
This is a far cry from 2010-11, when India’s GDP grew at 9.3 per cent, hinting that we had sailed safely through the stormy sea of the global economy.
From here on, the economy’s resurrection will depend on how the government tackles the ‘DIRE’ risks: D: deficits (governance, current account deficit, fiscal deficit), I: investment and inflation climate, R: recession in the Euro zone, and E: education and employment. We have made some headway in tackling inflation and fiscal deficit. However, a lot needs
to be done, and done fast to take the economy out of its current lows. 
Tackling Ds Governance deficit 
Good governance is the single-most important factor for sustainable growth and development. Weak governance affects investment climate, safety and security, education, health, and most importantly the credibility of and confidence in a country’s economic abilities.
Fiscal deficit
India’s government finances improved considerably in 2012-13 when the fiscal deficit to GDP ratio fell to 4.9 per cent from 5.8 per cent two years earlier. Composition of expenditure is equally important – we have begun to address this by limiting subsidies to less than two per cent of GDP. Towards this, in the past two years, the government has deregulated petrol prices, allowed gradual diesel price hikes and lowered the number of subsidised LPG cylinders.
While these moves helped the government curb expenditure last year, it will be critical to raise the tax to GDP ratio in a manner that does not hurt investment climate. 
Export-import gap 
Current account deficit (CAD) — the excess of imports over exports — reflects the demand for dollars. As we need equal amount of foreign capital inflows (dollar supply) to ensure that the rupee stays stable, a high CAD results in a volatile rupee. The CAD reached a record 6.7 per cent of GDP in October-December 2012, as a global slowdown pulled down exports, even as rising energy and gold imports drove up the import bill.
Within energy imports, coal imports have jumped due to the non-availability of domestic coal. Gold imports too surged to 12 per cent of India’s total imports in 2012-13 from seven per cent four years earlier.  A number of steps have been taken to lower gold demand — the latest being a hike in the customs duty on gold imports to eight per cent. However, gold demand will remain strong until other attractive investment options emerge.
The policy response should be to focus on creating investment options that are liquid, less volatile, easy to deal, and offer inflation-linked ret-urns.
Investment 
The means adopted to finance our high CAD has a bearing on the rupee’s value and volatility. In recent years, India  has become more dependent on volatile portfolio flows — in 2012-13 we received net FII inflows of $31 billion compared to only around $19 billion a year earlier. As the dependence on such volatile inflows render the  rupee vulnerable to sudden depreciation, we need to attract stable foreign direct inves-tments to finance the CAD.
Gross domestic investments climbed sharply to nearly 38 per cent of GDP in 2007-08 from 26 per cent in 2003-04, driving up GDP growth to over nine per cent. A two-fold rise in private investment over 2003-04 and 2007-08, aided the rise in overall investments. In the last couple of years, private investments have taken a big hit.
Mining bans and lack of speedy project clearances continue to hurt manufacturing and infrastructure activity. When key inputs — coal and power — turn scarce and costly, private investments will decline, as returns will be lower.
In 2012-13, growth in fixed investments slowed to 1.7 per cent from 4.4 per cent in the previous year. There is also an urgent need to speed up procedural approvals in the short term. With demand weakening, private consumption growth halved to nearly four per cent in 2012-13. With inflation declining, lowering interest rates would seem the immediate solution to raise domestic demand, there is not much room for to cut interest rates if we want to maintain inflation at current levels. In any case, high interest rate is not the primary factor holding back new investments.
Rather, policy and regulatory issues are the hindrances. 
Euro recession 
The Eurozone economy is expected to contract again in 2013 as Italy and Spain. Germany and France are also faltering. 
These concerns would continue to weigh on the risk appetite of foreign investors, keeping capital flows to emerging countries like India volatile. This poses a significant downside risk to the rupee.
Europe accounts for nearly one-fifth of our IT and ITeS exports and more than 15 per cent of merchandise exports. While downward revisions to the Euro zone’s growth outlook pose a downside risk to India’s GDP growth, a sharp downturn in India’s economy has more to do with domestic conditions.
Hence, reforms to improve domestic demand will remain critical and help offset any shocks from the global economy.  
Eemployment 
Creating job opportunities is central to inclusive economic growth. It also encourages more working-age people to seek employment. This expands the pool of both skilled and unskilled workers, which in turn will drive economic growth.
Between 2005 and 2010, net job additions rose marginally to 27.7 million from 27.2 million in the previous five years. Faster GDP growth in the middle of the last decade did not result in a significantly higher number of jobs.
Therefore, high and sustained economic growth will depend on a recovery in domestic investment, and consumption. A recovery in investments will in turn depend on the availability of key inputs such as power, regulatory reforms, speedy project clearances, and the state of infrastructure development.
Over the medium term, however, stable and low inflation and the ability to create jobs for a large unemployed workforce will be critical to boost consumption growth. Our economic future depends on how fast and how well we resolve these challenges. 
(The writer is principal economist at CRISIL. Views are personal)