On Tuesday, Cornell had the unique privilege of hosting Dr. Duvvuri Subbarao, Governor of the Reserve Bank of India (RBI) who presented a talk entitled “India in a Globalized World: Some Policy Dilemmas.” The lecture was delivered as a part of the Mario Einaudi Center’s Foreign Policy Distinguished Speaker Series. Earlier in the day, Governor Subbarao also interacted with a selected group of students over lunch. On both the occasions, Dr. Subbarao, who was appointed just a week before the 2008 Global Financial Crisis began, made a compelling case for the need for economic reforms, fiscal austerity, and capital investment for growth.
Subbarao traced the story of India’s growth from the early decades after independence when the country experienced what he called the “Hindu rate of growth”. The phrase suggests that the Hindu philosophy of fatalism is detrimental to economic development. However, it would have been much more appropriate to term India’s modest growth rate under Prime Minister Nehru as the “Communist rate of growth” as India’s early policy makers were enamored by the socialist model of the Soviet Union. But due to a series of economic reforms after the Balance of Payments crisis of 1991, India experienced rapid economic growth driven by a high savings rate, increased productive capacity, and an unprecedented demographic dividend.
Nonetheless, India’s growth story started fraying after the global financial crisis of 2008. Today, India is undergoing a period of moderate growth, excessive and persistent inflation, and large deficits in the government budget and current account. With oil prices remaining high and external demand not picking up, the policy space to respond to these problems has been shrinking. Last year India suffered a 6.5% GDP growth rate, the lowest in the past 9 years. Earlier this year, Standard & Poor put India on a watch for a credit rating downgrade.
Inflation, especially in times of faltering growth, is perhaps the most serious problem that the government has to deal with. While admitting that domestic food prices, depreciation of the rupee, fiscal deficit and demand pressures were contributing to inflation, Dr. Subbarao also tried to shift the onus on slow American recovery, global uncertainty, speculation in oil prices and geopolitical crises in oil-producing countries. But despite the RBI’s best efforts towards raising interest rates and tightening liquidity supply, inflation in India has not been brought down to the acceptable level of 5%.
It is often observed that there is trade-off between growth and inflation but in the curious case of India, growth has moderated while inflation has not come down. Although in the long run one might tolerate inflation for the sake of economic growth, in the short run inflation puts a severe regressive tax on the poor. Moreover, fiscal deficit obstructs the process of development and poverty alleviation if the government is borrowing for current consumption rather than capital formation. In such a case, austerity is required not only to encourage growth via fiscal consolidation but also to respond to the silent voice of the poor. In fact, Dr. Subbarao accepted that political compulsions are preventing the Indian government from reducing its deficit to an optimal level.
To some extent, Governor Subbarao is right in pointing towards the economic challenges posed by the external sector. Slow recovery in US and Europe has slowed down capital inflows and decreased the demand for Indian exports. Even with the depreciation of the rupee by more than 20% over the last several months, exports have failed to become competitive while imports have escalated due to a rise in the demand for oil and gold.
But then again, a lot needs to be done on the domestic front in order to curb speculation, encourage capital flows, and inspire investor confidence. Governor Subbarao indicated that some degree of intervention in the foreign exchange markets is appropriate and indeed advisable to protect the robustness of the economy from the externalities of US policy decisions. Such remarks might hint at forthcoming policy changes that may have repercussions on the exchange rates.
Recently, Ruchir Sharma of Morgan Stanley Investment Management warned in his book “Breakout Nations” that the illusion of rapid growth in the world’s emerging economies is coming to an end. In particular, India, due to its populist welfare-state liberalism, poor infrastructure, and rampant corruption under the present UPA government, faces the imminent prospect of getting strangled in a low income trap. But as Dr. Subbarao maintained, India must grow at an annual rate of 10% for the next 15 years if it wants to overcome its persistent problem of poverty. For this India requires serious rebalancing, from domestic demand to exports, from consumption to investment, and from services to manufacturing. And when central banks across Europe are debating on the issue of “fiscal austerity or growth”, Governor Subbarao’s insistence on “fiscal austerity for growth” seems to be a surprising but sound step. Perhaps, with a large and growing middle class market, a group of risk-taking and innovative entrepreneurs, and the reliance on democratic politics to resolve conflicts, India’s growth story will remain credible, if not inevitable.
