For Indian policy makers who often boast that the country has the fastest economic growth rate among the world’s major economies, yesterday’s monetary policy statement should be a rude awakening. RBI kept its policy interest rate unchanged at 6% in the backdrop of a marginal increase in its inflation forecast for the year. The wakeup call really came in the form of a markdown in its forecast of economic growth, as measured by gross value added, for 2017-18 from 7.3% to 6.7%. India’s growth rate has been marked down even as global economic momentum has gained traction.
This slowdown could not have come at a more inopportune moment. As the southwest monsoon did not meet early expectations, agricultural production is expected to be lower this year. A large part of the rural economy of course supplements its income from non-agricultural sources. For example, export-oriented manufacturing provides rural youth with additional opportunities. Here too, India’s performance has been disappointing. Even if merchandise export growth in August was 10.3%, overall the country’s performance has been lacklustre when juxtaposed with other emerging markets such as Indonesia and Vietnam. These new challenges have emerged even as older problems such as impaired balance sheets of some private firms and many public banks remain.
The last couple of years have of course seen positive developments too. For example, the return of stability in key macroeconomic indicators such as consumer inflation and the level of fiscal deficit. These hard won gains provide India with the platform to effectively deal with other challenges like an industrial slowdown and weak private investment. It is important that any solution to the new set of challenges does not fritter away the gains of the last two years.
At this moment, the best way forward is for policy makers to focus on smoothening the structural shift underway in the economy. To illustrate, RBI’s assessment is that GST implementation has had an adverse effect on the manufacturing sector. This problem can be quickly resolved by the federal GST Council, which can strongly push the ease of doing business agenda. Separately, attempts to solve the bad loan problem by using the bankruptcy law must be supplemented through adequate recapitalisation of banks. Policy response now should be to resolutely see through the economy’s structural transformation.