With falling inflation, high forex reserves and the new government embarking on a broad reform agenda, things seem to be looking up for India. In this article, Eswar Prasad shares his macroeconomic outlook for the economy. He provides his perspective on foreign inflows, disinvestment, fiscal position, the reform agenda, and escaping the low-growth trap.
Q: Global investors seem much more enamoured by India once again. In fact, the macro fundamentals have not even really changed sufficiently as to warrant this kind of enthusiasm. Is there a danger of hubris overtaking us once again?
Eswar Prasad: There is certainly a risk when international investors pile into one country with so much enthusiasm, but one has to recognise that we are still in a very low interest rate environment in the advanced economies. There is some notion of the US beginning to raise interest rates perhaps some time in 2015, but if you think about international investors looking for a place to get better yield than they can get in the advanced economies, there are few good options.
In China growth is slowing down, and other big emerging markets like Brazil, South Africa and Russia are facing very difficult economic circumstances. So India looks like the one bright spot and certainly with the inflation falling, the current account deficit coming under control and Prime Minister Modi beginning to embark on a fairly broad reform agenda, there is a sense that for India there is nothing but upside.
There is certainly the risk that if a lot of money comes in on the assumption that there is nothing in India but upside and then the Fed starts entering its interest rate tightening cycle, which leads to a pullback from the emerging markets, that is going to make things a little difficult for India. But still - with the rupee, where it is right now with a higher level of foreign exchange reserves than was the case about a year ago, and with the economy beginning to generate some momentum, India is a lot less exposed than many other emerging markets.
Q: How do you see the economy today? Is the improvement in our macro fundamentals real and sustainable or is it contrived and temporary?
Eswar Prasad: My hope is that it is something more durable. Certainly if one looks at the inflation picture, which looks a lot better than anyone had expected a few months ago, part of that is due to base effects, which the RBI itself has recognised are going to disappear.
If you look at the fiscal position, it is certainly improving in some dimensions, but again there has been a bit of a halt with revenues not coming as strong as one might have expected. I do not think we have solved the fundamental problems there as well.
And then as one starts looking at other issues of macro reforms on subsidies, infrastructure, and labour laws - on all of these, there is certainly a positive momentum, but we are a long way yet from saying that India has a durable recovery or is on a path towards sustained high growth.
Q: There has been a talk of a Modi dividend. Has the dividend played itself out completely and how long will this change in sentiment alone see us through?
Eswar Prasad: Now Mr Modi has certainly been very reluctant to lay out a very broad and sweeping agenda and I, among others, felt that it would have been useful if he could have started out by laying out a broad agenda and by beginning to pluck some low-hanging fruits in terms of reforms.
Q: Yes, the Modi government does seem to be opting for slow and gradual reforms rather than any big bang reform yet. There are many areas where we do need root and branch reform. So is this a luxury that we really cannot afford?
Eswar Prasad: The masses have to be convinced that this is in their interest. So getting governance right, dealing with the corruption problem - there is some logic to making sure that those elements are in place before you embark on very broad reforms. This is because in a country like India or for that matter China, there is always the concern that although economic reforms might benefit everybody in the long run, in the short run the benefits are largely going to go to the political and economic elite.
Bringing the masses on board, convincing them that the reforms are going to be in their interest even in the short run, there is a lot to be said for that. Now having said that there is still the issue that unless some of these reforms are put in place fairly quickly, all the other aspects such as the macroeconomic stabilisation and so on will not really put India on a high growth track.
Q: Financial inclusion, such as the Prime Minister’s Jan Dhan Yojana (PMJDY) and payment banks, appears to be a key component of Mr Modi´s vision. Can this be a game changes, or do you think that the effects will be small?
Eswar Prasad: The intentions behind the financial inclusion programme are very good ones — to increase access to formal financial services, reduce leakage in cash transfers from the government, and bring more savings into the formal financial system. The government is approaching this in an ambitious way and the results so far look promising. I view this as an important priority that allows the benefits of India’s growth to be shared more broadly, which, in turn, will build more support for a broad economic reform agenda.
Q: Disinvestment is back on the agenda in a big way. What do you think would be the best way to proceed?
Eswar Prasad: Disinvestment is a useful tool to reduce the state’s involvement in parts of the economy where it doesn’t necessarily have an advantage relative to the private sector. It will also have a positive effect on the government’s fiscal position, both in the short run and, if the disinvestment includes loss-making enterprises or financial institutions, in the long run as well. The key issue is to do this in a sensible way that maximises the value that can be extracted from these firms and also to avoid using disinvestment proceeds to delay more fundamental fiscal reforms.
Q: Could there be a case for a stimulus - either monetary or fiscal - to get us out of this low-growth trap?
Eswar Prasad: My view is that the focus on macroeconomic stabilisation, that is, bringing deficits and the level of public debt - apart from inflation - under control, is really the best contribution that the macroeconomic policy can play in terms of boosting growth. That is because ultimately even though fiscal and monetary policies might provide a short-term boost to growth, unless the structural problems in the Indian economy are sorted out - that lead to higher productivity growth, better allocation of resources to the financial system - we would not really have strong and durable growth.
So the conclusion would be that, rather than relying on short-term macroeconomic stimulus, we really need to focus on the structural reforms and taking the eye off structural reforms while focusing on macroeconomic stability might not serve the country that well either.
A version of this interview appeared in Economic Times.