India - Is this engine stalling ?

Not so long ago, India’s economy appeared robust. Overall growth was averaging 9 per cent per annum. Inflation was still in single digits. Business journalists were smiling. Although the world was experiencing a financial crisis due to the sub-prime mess in the United States, there was a sense that we were relatively insulated from all those bad things happening outside.

But of late, the shine seems to be off the India Story. Things are likely to get worse with a growth slowdown expected to hit 7.7 per cent or less. Inflation has climbed to double-digits.

Policymakers attribute these woes to adverse global developments. A flagging economy and galloping inflation do complicate the government’s policy response. If the choice is: either stimulate growth or fight the price rise, it’s a no-brainer that the choice will be the latter.

Ahead of crucial state elections and a national one in May 2009, there is no way that the ruling UPA can hope to get re-elected if double-digit inflation keeps ticking. The government’s stance is that if there is a price to be paid on the growth front to tackle inflation, well, so be it.

Thanks to tighter monetary measures — the first line of defence in the battle against inflation — such as raising interest rates, industrial production is losing momentum. Growth slumped to 5.2 per cent in three months ending June 2008 against 10.3 per cent in the same period in 2007. Consumer durables grew by a sluggish 3.8 per cent after having dipped by 0.7 per cent in the same period last year. Passenger car sales, in particular, have been hit and it’s a terrible time to service costlier home loans.

The tidings on agriculture are not too bullish either. Kharif (summer) crop-sowing operations have been affected by a truant monsoon. Although rains have revived things of late, water storage levels in reservoirs, especially in southern and western India, are below 10-year averages. According to the the Prime Minister’s Economic Advisory Council, growth is likely to slump to 2 per cent this year after growing by 4.5 per cent last year. The effect of
a subdued performance on demand for industrial goods will be felt after a gap of a year. In other words, overall growth is slowing.

But even if the priority then becomes fixing price rise, there are doubts whether this will be contained. The danger is especially on the food price front — thanks to adverse weather conditions. The southwest monsoon’s behaviour is a case in point. This will have serious implications for India’s agriculture. Deep Fish had alluded to the work of scientists in the Bangaluru-based Centre for Mathematical Modelling and Computer Simulation who observed that the monsoon’s spatial coverage had, in fact, been shrinking during the period 1951-2003.

Scarce rains in the affected regions hold out the prospect of agrarian distress. Small farmers and labourers subsisting on rain-fed agriculture, which characterises vast parts of peninsular India, are especially vulnerable. These regions experienced deficient rains during the month of July this year. As this month is crucial for sowing operations, this presages lower kharif food production and higher prices. Lower incomes hit demand for fast moving consumer goods that in turn will affect industrial and overall growth.

What is particularly relevant for the current dismal prospects of agricultural growth is that during the southwest monsoon season of June-September, the share of July rains has been falling when compared to June and August. It bears mention that near-drought conditions prevailed in Maharashtra this year due to scanty rains in July. Despite a revival in the monsoon, this state received less rainfall even during the second week of August. Karnataka and Kerala, too, have suffered due to a parsimonious monsoon.

Subsequent research on rainfall trends between 1813 and 2006 also corroborates that it is raining less. What ought to make policymakers take note is the decrease in precipitation received by three-fourths of India from the southwest monsoon, barring certain parts of Andhra Pradesh, Gujarat, West Bengal and Orissa. In the country as a whole, according to the recent work of scientists in the Pune-based Indian Institute of Tropical Meteorology, southwest monsoon rainfall declined by 4.72 per cent from 1931-1964 to 1965-2006.

The fact that the contribution of the southwest monsoon to the total rainfall is diminishing obviously has implications for the sustainability of agriculture. The substantial shrinkage in its geographical coverage also makes such affected regions steadily become unviable for cultivating certain crops. The consequences of a wayward monsoon are bound to be felt on the price front as there will be an inflationary bias for delayed sowing during the current kharif season for crops like groundnut, sugarcane and pulses.

How much of a slowdown in growth is an acceptable trade-off to lower inflation? Interestingly, an estimate by the RBI pegs this so-called ‘Sacrifice Ratio’ at 2. In other words, the Indian economy’s output will reduce by 2 percentage points below its potential or productive capacity with a reduction in inflation by 1 percentage point. As double-digit inflation hasn’t yet been reined in to more comfortable levels, the central bank will naturally be tempted to raise interest rates again for the fourth time since June.

The upshot is that the fug over India’s overall growth is unlikely to blow over soon as the full effect of the RBI’s monetary measures will kick in only from next year onwards. The state of the world economy, too, is far from buoyant to hazard any guess on how India’s performance will hold up. If the worst financial crisis since World War II results in a global slump, we can hardly be insulated from these developments. This much is certain. India is on a roller-coaster with the lustre off its growth story.