Danger Signals for the Indian Economy

Jul 11th 2002, Jayati Ghosh

The new Finance Minister, Mr. Jaswant Singh, has already declared his intention to try and increase purchasing power, especially of the domestic middle classes. Clearly, the government has designed this particular Cabinet switch of portfolios to restore the government's popularity, and therefore its electoral fortunes, before the next general elections. The aim, presumably, is to undo the damage to the BJP's middle class constituency which was caused by the last Budget presented by Mr. Yashwant Sinha.
But if this is going to be Mr. Singh's sole, or even major, preoccupation in the immediate term, then it may prove to be counter-productive. In fact there are far more serious danger signals looming, which suggest future trouble for the macroeconomy, and the Finance Minister will need to address these on an urgent basis if a future financial crisis is not to unravel all the attempts at economic recovery through generating more middle class purchasing power.
Consider the following features of the Indian economy at the middle of 2002. The economy is widely acknowledged to be still in recession, and though optimists have detected a turning point in recent months, there is little evidence to support this so far. The recovery in agricultural production was from the collapse of the previous year, and has been accompanied by further increases in the excess level of foodgrain stocks held by the public sector.
Industrial production decelerated further in fiscal 2001-02. The aggregate manufacturing index went up by only 2.7 per cent, and capital goods production actually declined by 4 per cent.  Only consumer durables bucked the trend; in all other industrial sectors, including infrastructure, the growth rate was well below 4 per cent. Investment has probably continued to stagnate, if not decline. One important indicator of this, the assistance sanctioned and disbursed by all the All-India Financial Institutions taken together, actually declined even in nominal terms by 23 per cent over 2001-02, to less than Rs. 56,000 crore.
Nevertheless, the balance of payments indicators are, if anything, booming. One extraordinary feature of the past fiscal year has been the dramatic and unprecedented increase in the external reserve position of the RBI, by more than $12 billion just over twelve months. By the end of May, external reserves stood at more than $56 billion.
What is behind this tremendous spurt in reserves ? What is clear is that it is not any development on the trade front which has contributed. Exports over 2001-02 were stagnant, growing at a negligible 0.1 per cent over the previous year (which was substantially below even the downscaled target of 4 per cent set by the Commerce Ministry.) Meanwhile, imports actually increased slightly, by 1.1 per cent, leading to a slight increase in the trade deficit. It is true, of course, that the current account has still been kept in check, essentially because of invisible payment inflows in the form of large-scale remittances from Indian workers abroad.
The real factor behind the increase in reserves has been the large increase in various short-term and debt-creating flows, as well as a dubious category in the balance of payments data called "errors and omissions", which essentially represents extra-legal capital flows. Foreign direct investment inflows (which includes mergers and acquisitions as well as Greenfield investment) amounted to just above $3 billion. But more short-term portfolio inflows by Foreign Institutional Investors along with purchase of shares by non-residents amounted to nearly $ 3 billion as well.

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