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1. Growth not at any cost

There is a general perception that the main cause of present economic crises in India is due to faltering growth rate (fall from 9% to less than 4.5%). It appears that many television channel debates hold the declining growth rate to be responsible for underlying cause of the current account deficit, inflation, massive currency depreciation and increasing fiscal deficit. This may not be a right analysis.

GDP rate is a reflection of private consumption, gross investment, government expenditure plus excess of exports over imports or minus excess of imports over exports. High levels of investments and government expenditure decide generating aggregate demand or contraction in case of fall in levels. Increase in govt. expenditure in freebies like subsidies or in non-productive expenditure like law and order and increase in govt. employees’ salaries all are responsible for increase in consumption without corresponding increase in production capacity. As regards the Indian scenario, investments to accelerate production capacities (like power generation, infrastructure) have been going down whilst private consumption, govt. expenditure and adverse gap between exports and imports have all been on the rise y-o-y. These three adverse factors have led to a falling GDP growth rate in India.

An ideal growth rate should be when govt. expenditure builds up supply-side economics. Once the govt.’s fiscal policy is directed in a manner that gives impetus to more savings and higher productive investments, automatically any increase in private consumption would be in some proportion to increase in supply-side of the economy. The point being made here is that even lower growth rates could achieve economic prosperity provided there are increasing and adequate savings, investments and commensurate govt. expenditure for productive purposes and not dolling out freebies without the beneficiaries having earned those goods. Thus, growth should not be at any cost.

Faltering growth rate in India cannot be said to be the problem of its economic ills. Fiscal policy makers need to target an ideal growth rate and driving the GDP components in a positive way. Unless the underlying components (savings, investments, consumption, govt. spending and exports-import gap) are properly designed, implemented and monitored, no amount of effort or talking could yield meaningful result. So, it’s a misnomer that economic ills in India are due to faltering growth rates. In my view, even an ideal growth rate of 2-3% could achieve to balance our budgets, resulting into a zero fiscal deficit and at the same time there will be a connect between demand and supply side economics.

Hence, even a moderate growth rate (lower than the present rate of 4.5%) could help India to get rid of its ever increasing fiscal deficit problem.  This is also the view of some of the well-known FIIs, as known from business TV channel interviews.

2. Cure for inflation

India has been experiencing very high levels of inflation, decades after decades of about 10%. This has significantly weakened the purchasing power of the currency. Not only this, any country that runs a high inflation, gets into the vicious circle of wage-price spiral. This causes a loss of investor confidence in the economy because no investor will like to see heavy inflation that will erode the value of their returns on capital, besides the real danger of monetizing a lower rupee value when they decide to move away their capital from India, for example, the FIIs taking out their capital back to the U. S. after the decision by the Fed to gradually end the stimulus in the form of quantitative easing by purchase of long term bonds in open market operations (OMOs). Inflation causes value losses to consumers and producers as they have to constantly work around their buying and selling prices, instead both of them concentrating on savings and investment. Inflation makes a hole in the consumers’ and producers’ surpluses that weakens an economy from its base.

So, what India policy makers need to do? Inflation can be controlled by the central bank following a contractionary monetary policy where the supply of money is restricted. The simple logic is that it is only the new money supply that leads to increase in prices because too much is chasing too few goods. Production capacity and supply is decided by use of factors of production (like raw materials, labour force, technology, land, water & other natural resources and entrepreneurship). If money supply is controlled, it can lead to reduction in aggregate demand and prices as well. This way, overheated economy can be brought to some sanity against bubbles in housing and electronic goods. Remember, when money supply was limited under the Gold Standards of Monetary Management followed until late 1950s in their true sense, inflation was pretty low.

According to some economists, the reason for Great Depression in the 1930s was linked due to the contractionary monetary policies followed by central banks in the U. S. and Europe. This was another extreme! The RBI needs to target a moderate inflation rate of say 2% and decide the quantum of money supply in circulation in the economy, to get a handle over inflation and address a major concern of international investors, consumers and producers. A proper monetary policy can rebounce the confidence in the economy from all stakeholders. The theory that inflation is caused by expansionary monetary policy led Milton Friedman, an American, to earn his Noble Prize in Economics in 1960s. His economic model was followed by Paul Volcker, the former U. S. Fed Chairman in the 1970s when inflation in the U. S. was reigning at 15%. He successfully controlled the U. S. inflation that resulted in lower growth rates in early 1980s followed by boom conditions in the 1990s.

It’s very important for the RBI to follow its monetary policy which is independent and a substitute of the govt.’s fiscal policy, in order to yield the desired result of lowering inflation.

3. Cure for current account deficit

India has been running a very high current account deficit of $70 billion that comprises excess of imports over exports and unilateral transfers. Current account deficits are bound to be financed by capital account inflows in the long run but such capital inflows aren’t the true answer to find a surplus in current account. All that capital inflows do is to make the balance of account to zero. So, it’s a cold comfort to see that capital inflows from foreign sources will take care of the deficit. India needs to scale new heights by becoming internationally competitive in various market segments. This will provide India to increase its exports. The China competitiveness model is worth its praise which has earned it the biggest holder of foreign currency reserves in trillions in the U. S. and in the EU. In short, India needs to become an export-led economy and lesser import-dependent.

India also needs to find its energy security by reducing its imports. We need to conserve fuel and energy from wasteful consumption, instead channel that consumption into fruitful production. We need to find domestic sources of energy supplies. Increasing R&D needs be taken in India in all significant imported goods. The U. S. has recently found its own shale gas reserves as an alternate to foreign oil which is being gradually explored to reduce foreign oil dependence. India also needs to achieve some breakthrough to save lots of foreign exchange. In fact, a lower GDP rate if properly targeted by the fiscal policy makers could turn current account deficit into a small to moderate surplus due to falling demand of imported oil and capital goods. A case in point is that EU member states have achieved a surplus in current account of $300 billion from a deficit of $100 billion, owing to eurozone recession or slowdown in growth.

4. Cure for currency depreciation of currency

Increasing competitiveness in international goods markets, targeted lower growth and inflation rates, controlled money supply policy and bridging fiscal deficit levels will all provide sufficient confidence to investors, producers and consumers. This will result higher savings and investments, putting lesser pressures for foreign currency demand. Rupee exchange rates in forex markets will get back to the $1=Rs. 40-45 range. There is nothing wrong with rupee as a currency. What needs to be cured are the underlying factors, especially to bring down imports and accelerate exports so that demand for reserve currency is brought down significantly and thus lifting the value of Indian currency in forex markets.


All the above policy measures, that is, a slower or lower growth rate (say 3%), targeted moderate inflation rate and limited new money supply (say 2%) and truthful implementation could retrieve India some lost economic glory. Policy makers should envision that India story is sited as a positive case study like that of China. We all live on hope that one day, sooner than later, Indian economy will return on a sound footing by proper steps of policy makers. However, it is equally the duty of consumers and producers to not to indulge in non-essential consumerism, save resources for tomorrow’s use. The recent continuing growth rate increase to 3% in the Japanese economy compared to over two decades of recession, post-newly elected government which has taken suitable policy measures is a pointer of the importance of the right fiscal and monetary policies for turnaround in an economy.

CS. Anand Varma

Company Secretary


September 2013  


Published by

Anand Varma, FCA; FCS.
(Former Partner -Big4 firm)
Category Others   Report

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