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Tough Times for the New FM

The state of the economy makes the task for the new finance minister rather difficult and full of challenges

Do not envy the individual who has occupied the most spacious room in North Block after Palaniappan Chidambaram. The new Finance Minister of India has a most difficult task ahead of him. Reviving investments to create jobs and controlling food inflation are the most daunting challenges. Next comes strenuous efforts to bring a bunch of fractious state governments together to thrash out a common goods and services tax. None of these goals can be achieved easily. The solutions are far from simple; the problems are complex and difficult to resolve.

The international economic environment and the domestic milieu are far from conducive for substantial inflows of foreign direct investments. With the rate of growth of the Chinese economy slowing down and the recession in Europe showing few signs of abating, the prospects of exports from India rising significantly in the near future are not particularly bright. Under the current circumstances, one can only hope that world prices of crude oil will not flare up suddenly to cause a sharp widening of the trade deficit, thereby putting pressure on the external value of the Indian currency.

The overall rate of growth of India's economy has decelerated considerably after the country's gross domestic product (GDP) grew by more than nine per cent three years in succession between 2005-06 and 2008-09 for the first time ever. In 2010-11 too, India's GDP again grew by over nine per cent. Over the last two years, however, the economy has grown by less than five per cent.

Also, for the first time in the history of India, food inflation is stubbornly refusing to come down despite having risen at double digit rates for the better part of the last six years. Persistently high prices of vegetables, fruits, milk, dairy products, fish and poultry have not just hurt the poor but also widened inequalities in an already highly-unequal society, thereby adding to social tensions and making ordinary people more angry than ever before about corruption and ineffective governance. Controlling inflation will be most challenging for the Finance Minister as this will require coordination and consensus-building not merely across government ministries but also across the political spectrum.

In the recent past, particular sectors of the economy have grown rapidly but declined or stagnated subsequently. For instance, the mining sector grew by 8.2 per cent in 2004-05 and by 7.5 per cent in 2006-07 but has performed poorly over the last three financial years. It is easy to blame interventions by the Supreme Court for this situation. At the same time, what is evident is that the imposition of restrictions in mining activities in different parts of the country were a direct consequence of rampant illegal mining that certainly could not have been allowed to continue.

As for manufacturing industry, consistently high rates of growth between 2004-05 and 2010-11 have been followed by a sharp decline in factory output with particular industries, notably automobiles, facing constriction of demand. Construction, which had been one of the fastest growing sectors, has of late also lost momentum.

Arguably the most glaring structural imbalance in the Indian economy is the fact that while at least half the population depends directly on farming for their livelihood, agriculture accounts for barely 18 per cent of GDP. Unlike many other countries where a reduction in the share of agriculture in GDP has been accompanied by a corresponding fall in its share of employment, this hasn't happened in India. The likelihood of a less-than-normal monsoon could make life even more difficult for the next Finance Minister.

It is unlikely that he will be able to curtail the various social welfare schemes that are currently in place, including those relating to the rights to work, food and education. He can, at best, try and put in place systems and checks that reduce leakages to ensure that these programmes reach intended beneficiaries. Which is very fine except that all of this is easier said than done. Even if more money is today in the hands of the rural poor, it is also true that food inflation and corruption have eroded a substantial part of the gains that may have accrued to the underprivileged in recent years.

Despite innumerable claims that economic growth in India has been 'inclusive', expansion of employment opportunities remains sluggish. Statistics put out by the National Sample Survey Organization (NSSO) show that the annual rate of growth of employment between 1999-2000 and 2011-12 was just 2.2 per cent per year, despite the fact that certain years in the decade witnessed rapid rates of growth of GDP.

While the broad investment rate and the savings rate both remain healthy by international standards at approximately one-third of GDP, by our own standards we need to do much better as there are distinct signs that citizens are saving less because of inflation. Compounding the problem, India's entrepreneurs have chosen to invest more abroad than within the country. They can crib about policy paralysis and poor infrastructure till kingdom come, but the fact is that there is little likelihood of investments picking up and more jobs being created in the near-term despite all the exhortations that are bound to be made by the new Finance Minister.

A huge problem that he will have to confront is the rise in the non-performing assets of banks that has been partly caused by the slowdown in industrial production. This problem cannot be wished away and entails taking stern action against some of the country's most prominent corporate captains, many of whom are gung-ho supporters of Narendra Modi at the time of writing this column.

The writer is an independent journalist and educator.

This column appeared in the June 2014 Issue of Mutual Fund Insight.