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India faces economic challenge

Dr Kaushik Basu, chief economic adviser to the Indian ministry of finance, speaks with Jim Middleton

China may be the world's standout economic performer of recent years, but India has not been far behind.

Just 12 months ago, economists were predicting that India could keep growing at eight or 9 per cent a year.

But now growth has slumped and Manmohan Singh's government is under attack for losing the will to push on with reform.

Dr Kaushik Basu is chief economic adviser to the Indian ministry of finance.

Kaushik Basu, welcome to the program.

JIM MIDDLETON: For quite a while India's economy was a star performer in global terms but now it's gone off the boil. What's the problem?

DR KAUSHIK BASU: You know, the Indian economy was doing very well from 1994, extremely well from 2003. It is only during the last year, 2011 12 that it has done poorly.

But poorly, you have to understand, it's really in comparison to India's quite remarkable performance before that. So the growth rate is down to 6.9 per cent, which is very disheartening in India given that just before that we were at 8.4 per cent. But, you know, it is also partly a testimony to the changing yardstick in India that we feel disappointed about 6.9. But the slow-down, 6.9, even if it is really in relation to what we've done in the past, is disheartening for us.

You ask what's going gone and what has caused that? I think there are two dominant factors. One is our domestic situation. We've had very high inflation for about two years and there has been a slew of policies trying to curb the aggregate demand in the country, and there has been a little bit of a negative fall out from that.

And the second, and the more important, India today, unlike 15 years ago, is a highly globalised country. We trade a lot, capital flows in and out of the country. So the global situation and the global queues get picked up by India very, very quickly. And the eurozone crisis and the uncertainties surrounding Greece in particular has meant an exit of foreign equity flows, and that has affected us in a very big way.

JIM MIDDLETON: You're talking about the outflow of foreign capital and the falling value of the rupee, but doesn't the devaluation of the rupee reflect on lack of confidence of foreign investors about doing business in India and isn't that a bit of a problem too?

DR KAUSHIK BASU: If you look at it in perspective of global currency movements, India's depreciation is completely in step with the South African rand, the Brazil real; the South Korean wan is also depreciating very sharply; the Mexican peso. So it is very international.

I think what is causing this recent loss of value of the Indian rupee is foreign institutional investors. Given the global uncertainty and suddenly up to the Greek elections of the 17th June, they are flying into the zone of safety which is US treasuries, German bonds, and a couple of other safe, secure national bonds that it is going into. It is this exodus which has affected the recent exchange rate movement.

JIM MIDDLETON: How worried, though, are you about the impact of the slump in the value of the rupee, especially given India's dependence on nondiscretionary imports, particularly oil?

DR KAUSHIK BASU: That I am indeed worried because we have to import a huge amount of oil. And for many of these products in India we continue to have a fixed price for Indian consumers. So ordinary Indian consumers do not get to feel the increase in global prices because it is held fixed by fiat. What this means is that when global prices go up, there's no cut back in demand for these products in India.

JIM MIDDLETON: Is there a danger then this could have a deleterious effect on the budget, the Indian budget given the impact of higher oil prices on fuel subsidies? You've got a budget deficit currently estimated at around 6 per cent I think. Is that sustainable if growth continues at its current lower levels and fuel prices remain so high?

DR KAUSHIK BASU: Our deficit last year was 5.9 per cent, so virtually six, you're right. This year we're targeting to bring the deficit down to 5.1 per cent. And the danger point is to do with fuel pricing, you're quite right.

However, what is likely to happen during the year, we don't quite know when, is some of these prices might be put on a partial float. If that happens, then that subsidy, those subsidies, will certainly begin to come down. There are other parts of the budget and our financing from which we will shore up the funds so that the deficit target that we have set for ourselves this year, 5.1 per cent, we are very, very serious about it, we want fiscal consolidation if for no other reason in order to put a cap on price index because inflation hurts. And as you know in a democratic setting there's nothing which distresses an electorate more than general price increases. So it's also in our political interests to be able to cap the fiscal deficit and through that to cap the inflation.

JIM MIDDLETON: You mentioned the difficulties of coalition government a short while ago. How seriously is policy paralysis undermining India's future prosperity? Action does seem to have stalled on a number of fronts: productivity, infrastructure, red tape, corruption, all of them, which must be inhibiting growth quite considerably?

DR KAUSHIK BASU: Yes. You know, the red tape we've lived with 50 years. I don't think that in itself is doing anything. It's something we should get rid of. But India was growing very rapidly despite some of the red tape which has been there, a legacy of old policies. But the slow-down in decision making that you're talking about, that is probably over the last year when we have had the coalition trying to take some decisions which have not gone through, some of the reforms, like we were trying to open up our retail sector to foreign direct investment. That came to the verge and was stalled.

But, you know, all this has happened over the last six to nine months. And if you look at some of the fundamental strengths, we save and invest, India today saves and invests the same way that the East Asian countries were doing in the heydays of their growth in the 70s and 80s. India's beginning to export in manufacturing products into countries that we did not do in the past.

So all these medium to long term trends speak very, very well. And I actually do believe that by the year 2015 India could be topping the world's growth table chart even though right now, admittedly, we are going through a difficult phase.

JIM MIDDLETON: Kaushik Basu, thank you very much.

DR KAUSHIK BASU: Thank you very much. Wonderful talking to you.
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