Page last updated at 15:26 GMT, Monday, 16 June 2008 16:26 UK

India's economy - reasons to be cheerful

Kaushik Basu
By Kaushik Basu
Professor of economics, Cornell University

Boatman in India
Inflation hurts the poor most

Oil and food shortages combined with rising inflation have created a sense of economic crisis in India and the mood is beginning to turn grim.

While the nation's growth rate even till last year has been a handsome 9% there is some indication that this will decline.

Current inflation is not only the highest in the nation in the last eight years, but the rate at which the inflation itself is rising (the inflation of inflation) is extremely high.

It is likely that within the next few months the inflation rate curve will cross the growth rate curve. This has not happened in a long time and adds to the concern.

Is this just a passing cloud or a foretaste of the end of what has over the last four or five years been widely touted as India's economic take-off?

Persistent flaws

Predicting economic trends is always hazardous, but if one went beyond the headlines to the data, there would be reason to conclude that the long-run prognosis for India continues to be good.

This will entail some skilful policy crafting and so, in making this forecast, I am keeping my fingers crossed that the government, no matter which one it is 2009, will be astute enough to do it right.

The analysis is predicated on two broad "facts".

What can destabilise growth is political instability and nothing fuels this more than when large segments of the population feel left out of the mainstream

First, while there are important and persistent flaws in India's policy regime, this particular crisis is not its own doing. It is a global phenomenon that has washed up on the nation's shores.

This therefore compares with the downturns of 1997-1999 and 1972-1974, when there were major global crises and India was hit by them.

The 1972-4 crisis is of particular relevance, since that was also caused by a steep rise in global oil prices.

It was a classic case of stagflation. Prices rose rapidly and growth slowed down. India's inflation rate at that time had inched towards (but never reached) 20%, and that remains the record for independent India.

The 1997-9 crisis, which started in East Asia, also caused a slow down in India's growth rate, which had reached 7% per annum for three years before that and dropped down to 4.5% in 1997.

Petrol station in Delhi, India
The steep rise in global oil prices has hit India

But these happened when India was a much more closed economy.

There is reason to expect that we will be rocked much harder this time, since the nation is much more open now.

I should hasten to add that this must not be construed to be a case for keeping the economy closed.

The vastly higher growth that India has enjoyed since 1994 is largely because of the more open policies.

To close the economy would amount to opting for perpetual poverty in order to avoid the crisis of occasional poverty.

The second reason for optimism is that India is today one of the highest investment economies in the world.

It saves and invests around 35% of its national income. This is a recent feature of the Indian economy and is comparable to the best-performing East Asian countries.

Judicious mix

Arguably no other macroeconomic variable correlates with a nation's growth rate as well as the investment rate - this augurs extremely well for India's long run growth.

The catch however is in the qualifier "long run". The next year is likely to be very tough on the nation since inflation in a poor country is a curse.

So many Indians live so precariously close to subsistence that inflation can easily tip them over the edge. In the immediate run, the government has to use a judicious mix of market interventions to protect those who are the poorest.

In the longer run much will depend on how well we can create jobs to absorb the surplus labour.

Shopping mall in India
The economic boom originated in a crisis in 1991

This cannot be done by government alone through subsidies and public-sector jobs.

We need to craft policies to encourage the private sector to expand and use more labour.

This requires three critical changes: better infrastructure, less bureaucracy and more flexible labour laws, which allow for different kinds of contracts and permits firms to lay off workers when demand is slack.

Research shows that policies that making it easier to lay off workers, somewhat surprisingly, create more net employment.

What can destabilise growth is political instability and nothing fuels this more than when large segments of the population feeling left out of the mainstream.

Hence, poverty and unemployment need combating urgently.

A crisis can be an opportunity.

It was the crisis of 1991 that set India on the path of reform. The present global crisis will mean that firms and corporations in industrial nations will look for ways to cut costs.

If a poor country like India can put its house in order and be pro-active in the global market, it can be a critical player in helping corporations cut costs. At the same time it would improve its own economic prospects.

So expect some belt tightening, but don't expect the trousers to fall down.

The following are some of your comments in relation to Kaushik Basu's views:

While the global run-up in commodity prices can easily be held responsible for the inflationary pressure in India, let's not forget that over 40% of produce rots on its way from the fields to the bazaars of India. If supply chains were allowed to become more efficient by permitting organised retail, the demand side of the equation would certainly improve, thereby reducing food prices - this is perhaps the best way of easing the burden of inflation on the poorer sections of Indian society.
Anirban Lahiri, India

This is a good and balanced article. However, I am not so sure how it will look like India in the next one-two years to come. Both state and central governments are spending too much. Then there are the problems of corruption and inefficiency to deal with....if we do not address these issues we shall not succeed. How many criminals are in the power! We need good, corrupt-free accountable people in our government offices.
Kesavan, UAE

Another well argued article Prof Basu. I've noticed that you have not used the word "innovation" in your article. Shouldn't today's economic crisis be a motivation for not only countries such as the US and Japan, but also for India to develop scalable alternatives to hydrocarbon fuels? There seems to be no national consensus in the form of effective policies to drive research institutions to innovate more than what they are doing today.
Shreyas Attavar , Shreyas, Indian Institute of Science, Bangalore

I hope Prof Basu will be right. But the wording seems to bring up memories of the famous remark of Sir J. M. Keynes, that in the long run we are all dead.
Lars, Denmark

The author's analysis is incisive. However, he fails to understand the political climate that prevails in India. Indian polity thrives on the fissures between haves and have-nots, upper and lower castes, majority and minorities, rural and urban population. The political elites of India do not have any incentive to change the status quo. Even the much discussed reforms of 1991 were imposed on India by IMF, they were not triggered by any genuine introspection.
Rajendra Shenoy, Germany

I do not understand the author's justification for excessive cheerfulness, though I feel there are reasons for optimism. Indians of all economic sections have been greatly hit by inflation and continuing governmental inefficiencies that just wastes our tax money.
Anirban, India

"This requires three critical changes: better infrastructure, less bureaucracy and more flexible labour laws, which allow for different kinds of contracts and permits firms to lay off workers when demand is slack." In India, labour laws are non-existent for 95% of the population working in the "informal sector" (or lawless sector.) It can be a critical player in helping corporations cut costs. At the same time it would improve its own economic prospects. For manufacturing, exploding transport costs may bring globalisation in India to a screeching halt. We may have arrived too late on the market.
Ganesh, India

India is down but not out. Remember that in times of economic hardship - like now - its people are resilient. Our poor planning in dealing with the negative impact of globalisation has presently put India in a poor light, but I am sure we will overcome!
Subash Patel, India

India also needs to show the communists the door. When was the last time any of they did anything for India? During the days of the Raj, instead of helping those who were working to achieve India's independence, they were busy conniving with Britain to keep India in chains. After Independence, all they did was dance to the tunes emanating from Moscow and Beijing. Now, given the disproportionate influence they seem to have in the electoral dynamics, all they have managed to do is run two states with the greatest potential in terms of human resources into the ground. At the same time they have held up our efforts to modernise the economy.

Prof Basu is always quick to push the cause of the capitalists, more labour reforms, infrastructure etc. But farmers committing suicides, child labourers being exploited and environmental issues that India faces today are strangely absent from his version of a "crisis". Perhaps if India and the global news media did more to highlight these other crisis, they too could be turned into an opportunity for more sustainable livelihoods, workers rights and the preservation of the environment.
Vikram, Austin, Mumbai, India

Yes, the policies mentioned above must be implemented to improve India's economy. Let's hope that a new government, if there is one, will bring in new younger blood to move India toward a newer more efficient government. India's bureaucracy must move forward, it is possibly the most outdated part of the national framework of India. The middle class has been frustrated with excessive bureaucracy for years, and they must stop holding the nation back.
Sheahan Nariman, India

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