Why Chidambaram should not be overconfident about India’s economy

P-CHIDAMBARAMVivek Kaul  
In the recent past, politicians belonging to the Congress led United Progressive Alliance have often remarked that India will be back to a high economic growth path over the next few years. The latest such comment came from finance minister P Chidambaram on January 16, 2014. As Chidambaram said “As global economy recovers and as new measures take effect, I am confident that Indian economy will also get back step by step to the high growth path in three years.”
This confidence seems to suggest that high economic growth in India is a given and come what may it will come back. But history suggests that is clearly not the case. Economic growth can never be taken for granted.
The Global Emerging Markets Equity Team of Morgan Stanley in report titled 
Tales from the Emerging World dated January 14, 2014, points out “In a recent paper, former [American] Treasury Secretary Lawrence Summers warns that of all the factors that drive economic growth the one with the most clearly proven predictive power is simple regression to the mean.” Regression to the mean is a technical term which essentially means that a variable that is highly distinct from the norm tends to return to “normal”. Summers has co-authored the paper titled Asiaphoria Meet Regression to the Mean with Lant Pritchett.
In simple English what Pritchett and Summers are saying is that high economic growth rates tend to revert to their long term averages. As they write “Episodes of super-rapid growth tend to be of short duration and end in decelerations back to the world average growth rate. Both China and India are already in the midst of episodes that are historically long and fast.”
Hence, high economic growth rates can never be taken for granted. “The growth rate, even in successful economies, will tend to revert to the long-term average for all economies (which is about 1.5 to 2 percent). Summers[along with Pritchett] analyzed all 28 nations that, since 1950, have experienced periods of “super rapid growth” of more than 6 percent a year. These booms tend to be “extremely short lived,” with a median duration of nine years, and “nearly always” end in a significant deceleration, with a median deceleration of 4.65 percentage points to an annual GDP growth rate of just 2.1 percent, or “near complete regression to the mean.” In short, the nations catching up most rapidly now are increasingly less likely to continue catching up in the future,” the Morgan Stanley authors point out.
As mentioned, periods of high economic growth rates last for a median period of 9 years. The research paper considers data up to 2011. And by that time, 
the economic growth in India had lasted for a period of around 8 years. In China, it had lasted 32 years.
While Indian politicians might like to think that it is just a matter of time before economic growth comes back, that may not be the case. As Pritchett and Summers write “The single most robust and striking fact about cross-national growth rates is regression to the mean. There is very little persistence in country growth rates over time and hence current growth has very little predictive power for future growth.” Given this, just because the Indian economy has grown at a high growth rate between 2004 and 2011, that does not mean that it will continue to do so in the future as well.
Pritchett and Summers do not get around to explaining the major reasons behind why this happens (the research paper is still work in process). But one of the reasons they point out is the rule of law. As they write “we suspect that the reason for slowdown that will come in China and India is for a similar reason but which will manifest differently given the very different politics. That is, in neither country does investor confidence rely on rule of law.”
But there is other research which points out why poor countries are not able to sustain high economic growth beyond a point. As the Morgan Stanley authors point out “New research, however, shows that “development traps” can knock countries off the catch-up path at any income level. The challenges of developing industry — backed by better banks, schools, regulators, etc. — do not accumulate and confront an economy all at once. They continue to harass an aspiring nation every step up the development ladder.” This is already playing out in India.
In fact, countries flatter to deceive, do well in one decade and don’t do well in the next. “In some cases, development traps can drag newly rich countries back to the middle income ranks, as has happened in the last century to Argentina and Venezuela. Since the late 1950s, many nations have also slid back from the middle to the lower income class, including the Philippines in the 1950s, and Russia, South Africa and Iran in the 1980s and 90s. On average, more nations regress to a lower income level than advance to a higher one. And every decade tosses up new convergence stars — from Iraq in the 1950s to Iran in the 60s and Malta in the 70s — that burn out in the next decade,” Morgan Stanley authors point out.
Hence, sustained economic growth is a very rare phenomenon. And just because India has grown at a fast economic growth rate in the past, it may not do so in the future. The highly optimistic UPA politicians need to start by at least appreciating this point. 

The article originally appeared on www.firstpost.com on January 21, 2014 
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Chidambaram has got a Rs 2,22,000 cr problem

P-CHIDAMBARAMVivek Kaul 

The finance minister P Chidambaram has got a Rs 2,22,000 crore problem.
And he needs to tackle it before the current financial year ends on March 31, 2014.
In fact, the truth be told, by now he should have already started battling it, that is, if he hopes to successfully tackle it, as he has claimed on numerous previous occasions. 
The Controller General of Accounts, a part of the finance ministry, declares fiscal deficit data every month. Fiscal deficit is the difference between what a government earns and what it spends. 
Between April and November 2013, the first eight months of the financial year, the fiscal deficit stood at Rs 5,09,557 crore. This works out to be at 93.9% of the annual target. The fiscal deficit target set at the beginning of the year was Rs 5,42,499 crore. 
If this target has to be met then the government cannot run a fiscal deficit of greater than Rs 32,942 crore( Rs 5,42, 499 crore minus Rs 5,09,557 crore) between December 2013 and March 31, 2014. This means the government can run an average fiscal deficit of around Rs 8,235 crore per month (Rs 32,942 crore/4) during that period.
And this is where the problem starts. Between April and November 2013, the government ran a fiscal deficit of Rs 5,09,557 crore or around Rs 63,695 crore (Rs 5,09,557 crore/8) on an average per month. If the fiscal deficit target has to be met the fiscal deficit of Rs 63,695 crore per month needs to be brought down to Rs 8,235 crore per month. 
This implies a gap of Rs 55,460 crore per month or Rs 2,21,840 crore (Rs 55,640 crore x 4) over a period of four months. And this is what I called Chidambaram’s Rs 2,22,000 crore. 
To put things in perspective the average fiscal deficit of Rs 63,695 crore that the government has run in the first eight months of the year is 7.7 times the fiscal deficit of Rs 8,235 crore that it needs to run over the period of December 2013 to March 2014, in order to meet the target. 
Chidambaram has asserted time and again that the fiscal deficit target is a ‘red line’ that will not be crossed. So how will he ensure that the government does not cross the red line? One way is to hope and pray that the government earns what it had targeted at the beginning of the year. 
The receipts(or what the government hopes to earn) targeted for the year are Rs 11,22,799 crore. Of this only Rs 5,11,638 crore has been earned during the first eight months of the year. Hence, the government hopes to earn Rs 6,11,161 crore between December 2013 and March 2014. 
The government earnings tend to be back-ended, that is, a lot of money comes into its coffers during the last few months of the year. But even after taking that factor into account the situation doesn’t look good.
Tax collections form nearly four fifths of the government’s earnings. And things clearly look slow on this front. During the period April to November 2013, the government has managed to collect around 44.8% of its annual target. During the same period last year the number was at 47.9% of the annual tax target.
The average tax collected for the first eight months of the financial year between 1997-1998 and 2012-2013, the data for which is available online, was at 48.92% of the annual target. This clearly tells us that the tax collections have been slow this year. 
Also, the only year since 1997-98, when the tax collections during the first eight months have been lower than the current year was 2001-2002. During that year, the number had stood at 40.8% of the annual target. 
A sluggish economy is the best explanation for lower than usual tax collections. In fact, a
 report in The Economic Times suggests that “indirect tax estimates may have to be revised downwards by at least Rs 30,000-35,000 crore from the budget estimate of Rs 5.65 lakh crore.” Given this, the government is most likely to miss its tax collection target. 
Hence, the only way the government can hope to meet its fiscal deficit target is by cutting expenditure. One way of doing this is by delaying payments. News reports suggest that around Rs 85,000 crore that needed to be paid to oil marketing companies and fertilizer companies to compensate them for oil and fertilizer subsidies, will be postponed to next year. 
The government also seems to be delaying tax refunds. “Exporters are unlikely to get any more duty refunds for the rest of the year as field officials look to maximise revenues in the remaining three months of FY14,” The Economic Times report referred to earlier points out. 
Another report published in The Economic Times points out “The government’s zealousness in squeezing expenditure to meet the fiscal deficit target, either by delaying payments or not awarding new contracts, may be hurting those most vulnerable to such tightening — small and micro enterprises, self-employed professionals and the retail trade.” 
Further, the government expenditure is categorised into two kinds—planned and non planned. On the expenditure side, the cut is more likely to be on the planned expenditure side than non -planned expenditure.
Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government. Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government can at best delay paying subsidies. 
Hence, when expenditure needs to be cut, it is the asset creating planned expenditure which typically faces the axe and that is not good for the overall economy. If one looks at the numbers that is the direction they point towards. Between April and November 2013, the non planned expenditure of the government stood at Rs 7,30,203 crore or 65.8% of the annual target. 
Common sense tells us that if the expenditure is spread across evenly all through the year, in eight months the government would have spent around two thirds (or around 67%) of the target. And this is what it has done. This is not surprising given that non-plan expenditure is largely regular expenditure. 
As far as planned expenditure goes, during the first eight months of the financial year only Rs 2,90,992 crore or 52.4% of the annual target of Rs 5,55,322 crore, has been s
pent. This means for the period December 2013 to March 2014, Rs 2,64,330 crore of planned expenditure still needs to be made. And this is where the expenditure cuts will come in, if the government wants to meet its fiscal deficit target.
Planned expenditure is of the asset creating variety and is good for economic growth. When planned expenditure is cut, it hurts economic growth. But the choice is between the devil and deep sea. If the fiscal deficit target is breached, then international rating agencies will downgrade India to junk status. And that will create its own share of problems.
 

The article originally appeared on www.firstpost.com on January 4, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

With GDP growth at 4.8%, Chidambaram is finally speaking the truth

 P-CHIDAMBARAMVivek Kaul  
Abraham Lincoln once said “You can fool some of the people all of the taaime, and all of the people some of the time, but you can’t fool all of the people all of the time.” The finance minister P Chidambaram finally admitted the truth yesterday. “Consumer inflation in India is entrenched due to high food and fuel prices and monetary policy has little impact in curbing these prices…There are no quick fixes for inflation, will take some time to fix it,” he said.
“Demand is being stoked by the fact that we have high fiscal deficit and that fiscal deficit was not contained for a fairly long period, I think over a period of two years,”
 Chidambaram added.
What Chidambaram meant was that the government over the last few years has spent much more than it has earned, and has been running huge fiscal deficits. This money has not gone into creating physical infrastructure but largely been given away in the form of various subsidies and so called social programmes of the government.
This spending led to an increase in private consumption, which led to inflation, with too much money chasing the same amount of goods and services. And now the inflation is so well entrenched that it refuses to go. In October 2013, the consumer price inflation stood at 10.09% in comparison to 9.84% in September, 201.
One of the things that inflation does is it kills economic growth. And this is very much visible in the second quarter gross domestic product (GDP) growth number that was announced yesterday. For the period between July and September 2013, GDP growth, which is a measure of economic growth, stood at 4.8%, in comparison to the same period last year.
It was slightly better than the 4.4% GDP growth seen during the first quarter of the year i.e. the period between April and June, 2013. This was the fourth consecutive quarter in which the GDP growth has been below 5%. During the same period last year, the GDP growth had been at 5.2%.
The overall GDP growth was helped by a very good growth in agriculture (actually agriculture, forestry and fishing), which came in at 4.6%. This was much better in comparison to 2.7% growth between April and June 2013 and 1.7% growth between July and September 2012. The primary reason for a robust growth in agriculture has been the good rainfall that the country received during this monsoon season.
As Ashok Gulati, Shweta Saini and Surbhi Jain write in a discussion paper titled 
Monsoon 2013: Estimating the Impact on Agriculture released in October 2013 “Of the 4 broad regions of India: the north‐east, the northwest, the central, and the south peninsular India, as categorized by Indian Meteorological Department (IMD), with the exception of north‐east India, all the other three regions received normal or above normal showers.”
This has led to a robust growth in agriculture. As Gulati, Saini and Jain point out “All this is a very good news for a country’s agriculture, where 53% of the gross cropped area is still rain‐fed, and monsoons alone account for more than 76% of the total annual rains. No wonder then that years of good rains are associated with robust agriculture GDP growth.”
A robust growth in agriculture doesn’t help beyond a point because it forms only around 10.8% of the overall GDP (at factor cost at 2004-2005 prices). Manufacturing which is around 14.8% of the total GDP(at factor cost), grew by just 1%. Even though its better than 0.1% growth seen between June and September 2012, 1% growth clearly isn’t enough.

Trade, hotels, transport and communication, which form nearly 28.1% of GDP at factor cost, grew by 4%. But the growth had been at 6.8% between July and September, last year. Community, social and personal services which form around 14.3% of GDP (at factor cost) grew by 4.2% compared to last year. This was half the growth of 8.4% seen during the period between July and September 2013.
All these factors contributed to a sub 5% GDP growth. High inflation remains a major reason for the same. Lets try and understand how. GDP can be measured in different ways. One way is to measure it from the point of view of various industries and agriculture i.e. factors of production. This is referred to as GDP at factor cost, and this is the measure I used earlier in the piece. So we saw that the GDP growth when measured from this point of view was at 4.8%.
Industries depend on demand from people. When people spend money, it translates into demand for industries, and this in turn leads to GDP growth. But there are situations when people can’t spend as much money as they had been doing in the past. One of the reasons is high inflation where prices of goods go up, leading to people cutting down on what they think is unnecessary expenditure.
This is reflected in the private final consumption expenditure(PFCE) number which is a part of the GDP number measured from the expenditure point of view. The PFCE for the period between July and September 2013 grew by just 2.2%(at 2004-2005 prices) from last year. Between July and September 2012 it had grown by 3.5%. The PFCE currently forms around 59.8% of the GDP when measured from the expenditure side.
Hence, if it grows by just 2.2%, it slows down the overall GDP growth. This is because a slowdown in consumer demand means less business for industries and this impacts GDP growth. This is how inflation kills economic growth.
So the question is where will GDP growth go from here? Montek Singh Ahluwalia, the deputy chairman of the Planning Commission, 
is as usual optimistic and he expects the GDP growth rate “in the second half of the current year to be better than the first half.” But that’s what Ahluwalia has been doing for the last few years, forever trying to tell us that the next quarter, the next six months and the next few years are going to be better. He has become a seller of the great Indian hope trick.
Chidambaram was a little more realistic and he felt that the GDP growth will be close to 6% in the next financial year (i.e. between April 1, 2014 and March 31, 2015)and 8% by 2016-2017(i.e. between April 1, 2016 and March 31, 2017). “India will get back to the high growth path,” he said.
But inflation remains the main bottleneck if India has to go back to what Chidambaram calls the high growth path. The only way for controlling inflation is to cut down on government expenditure and the fiscal deficit. And that is easier said than done. In fact, as per data released by the Controller General of Accounts yesterday, the government has already reached 84.4% of the annual fiscal deficit target during the first seven months of the year i.e. the period between April and October 2013.
To conclude, India needs to grow at a much faster rate if there has to be any hope of getting many more people out of poverty. Ruchir Sharma, author of 
Breakout Nations and the head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management, explained the situation best in something that he said at a  literary festival in Mumbai late last year. As Sharma put it “People tell me that if India grows at 5% what is the big deal because that is still faster than the US or many of the European countries. And my response to it is that is the wrong way of looking at it because if India grows at 5% per year, India’s per capita income is really low and it is far too low to satisfy India’s potential and for India to get people out of poverty. And which is why India’s case of a 5% growth rate is a big disappointment.”
And now we are not growing at even below 5%.
The article originally appeared on www.firstpost.com on November 30, 2013
 (Vivek Kaul is a writer. He tweets @kaul_vivek)