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India’s Economy: Why Raghuram Rajan sees hope

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India’s Economy: Why Raghuram Rajan sees hope

All is not well with the state of the Indian economy. Growth has slowed down, Inflation continues to be a big headache, current account deficit is yet to come down to reasonable levels. And to add to that, economists worldwide have reduced growth forecasts for India.

But RBI governor Raghuram Rajan is not worried. At least not yet. Speaking at the Harvard Business School he said that the slowdown is a result of “substantial fiscal and monetary stimlus". This money was pumped into the economy to deal with the fall out of the global financial crisis in 2008. The resulting growth meant a rise in inflation and to tackle that the RBI had to keep monetary policy under a tight leash. High interest rates hurt investment by companies and also consumption.

Here are some takeaways from his speech:

1) India’s problems are not structural

According to Rajan, the current slowdown in economic growth is not a structural problem. He believes that India can get its economy back on track with “modest reform” and is capable of managing its fiscal and current account deficits.  He has a realistic and practical road map, “The immediate tasks are more mundane, but also more feasible ones: clearing projects, reducing poorly targeted subsidies, and finding more ways to narrow the current-account deficit and ease its financing.”

2) Deficits could narrow

A fiscal deficit occurs when a government’s expenditure exceeds its income. Similarly, a current account deficit occurs when a country’s foreign exchange payments exceed its foreign exchange earnings. The twin deficits are one of India’s key problems along with high inflation.

In the last fiscal, the government promised to cut fiscal deficit to 5.3% of GDP. It managed to bring it down to 4.9% of GDP in 2012-13. For the current fiscal, the government is aiming to reduce it further to 4.3% of GDP. Raghuram Rajan is also confident that the current account deficit (CAD) will be reduced to $70 billion or 3.7% of the Gross Domestic Product – a measure of the economy’s size. CAD widened to lifetime-high of $88 billion or 4.8% of the GDP.

3) Good monsoon

The monsoon season is a key driver of growth for the country. This is because a good season of rain translates into a bumper harvest for farmers which means higher earnings. This fuels consumption in rural areas and is positive for industrial growth. A prolonged slowdown in the economy, high interest rates and high inflation dampened demand but the RBI governor forecasts a change in fortune. A good monsoon “will spur consumption, especially in rural areas, which are already growing strongly, owing to improvements in road transport and communications connectivity,” Rajan noted.

4) Banking sector robust

The slowdown in the economic activity has had a direct impact on the banking sector. There is a sharp surge in bad loans. Raghuram Rajan’s logic is that the rise in bad loans is often owing to investment projects that are not unviable but only delayed. He believes that as these projects come on stream, they will generate the revenue needed to repay loans. “India’s banks have the capital to absorb losses,” Rajan said.

As mandated by the RBI, banks set aside a portion of their assets to cater for bad loans. This helps banks maintain their financial viability in case bad loans rise.

5) India’s finances strong

The RBI governor explained that India’s financial situation is stronger when compared to other emerging economies. “India’s overall public debt/GDP ratio has been on a declining trend, from 73.2% in 2006-07 to 66% in 2012-13 (and the central government’s debt/GDP ratio is only 46%),” said Rajan. He believes that these figures are proof enough that Indian economy is not in a crisis situation.

6) Favourable external debt burden

Rajan is bullish on India’s external debt situation calling it “favourable”. An external debt is the money a country’s borrows overseas. While India’s external debt at 21.2% of GDP rose significantly in the last six years, much of it is due to the borrowing by the private sector. The short term external debt is only about 5.2% of GDP.

Rajan pointed out that India’s foreign-exchange reserves stand at $278 billion which is about 15% of GDP. “Forex reserves are enough to finance the entire current-account deficit for several years,” he told the Harvard Business School gathering.

7) Infrastructure improvement

For a developing country like India, infrastructure is the backbone of the economy. To tap into demand, the country needs to boost investment into infrastrcuture. Large infrastructure projects like the Delhi Mumbai Industrial Corridor project will boost economic activity in areas around it, Rajan said. The $90 billion project will link Delhi to Mumbai’s ports passing through six states, and will entail nine industrial zones, a mega power plant, three ports and high speed freight lines.

To conclude, RBI governor is confident that “despite its shortcomings, India’s GDP will probably grow by 5-5.5% this year, not great, but certainly not bad for what is likely to be a low point in economic performance” And he believes that “the path to a more open, competitive, efficient, and humane economy will surely be bumpy in the years to come. But, in the short term, there is much low-hanging fruit to be plucked.”

According to Raghuram Rajan, “The best of India is yet to come.”

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