Should we accept a lower level of growth?


Recently RBI came out with a report on how inflation impedes growth rates and they also published reports on the threshold level of inflation, from where it starts hurting growth.
Inflation does act as force against growth, but I was just wondering if it is not growth itself that leads to inflation.So inflation tends to act as a self correcting mechanism.But by repeatedly flaring up, as in the case of India, does it raise a red flag on the sustainable level of economic growth that can be targeted?


I dont know the answer but I will try to get a sense.
My analysis is very basic.I am neither capable nor equipped to do some hyper-mathematical regression to come up with a conclusion.

There are "n" commodities that go into making an economy and their weighted price index gives an indication of the inflation levels in the economy.

But I will concentrate on the basic commodities. Almost all other commodities are derivatives of these basic commodities and inflation in these basic commodities is what should generally be the driver of all other inflation.


The following is a table with growth rates for various basic commodities

Let us have a look at them:

Coal – We did well on Coal production before 2010-11. But last year was major disappointment. It looks like it will be worse this year. Looking at the overall scenario as of now, it is fair to asume that we are on are way to higher and higher coal imports.

Natural Gas – We were struggling to satisfy domestic demands and had a lot of hopes pinned upon the KG D-6 gas. It came in 2009-10. But now given recent problems, it looks like KG D-6 will struggle for production and so will India as a country as far as Natural Gas production are concerned. It should not be surprising that there are quite a few plans on the table to setup LNG terminals to enable import of LNG.


Crude Oil – That has been our weakest link in energy. Cairn Energy's find produced a bump in the production but now we are going to struggle again to grow it in any meaningful manner.

Except coal, we were always struggling with other energy sources.It had its own side effects of deficits and inflation but we somehow managed as global liquidity push helped India with capital inflows.
But now it looks as if coal is also going to go the crude oil way.

With limestone in abundance, we managed to get enough of our cement capacity in place.

Electricity - which is almost a derivative of coal in India, has done well. But with increasing problems in coal sourcing, it looks likely to struggle.

Steel has had a good going but even though we have abundant iron ore, we will have to import increasing amounts of coke to sustain steel production growth.

Fertilisers - that has gone nowhere. And no new capacities coming up, is likely to go nowhere.


Besides steel and cement, we will have to imports increasing amounts of all other basic commodities if we have sustain our growth momentum.

So where is the problem?


The problem is that all this leads to increasing trade deficits and we require higher amounts of foreign capital inflows to sustain our external balances.Higher Capital inflows helped us grow fast in the last decade.

But if we are going to struggle to produce enough of these basic commodities going ahead, our problems are going to exacerbate.And what happened in 2008 in terms of currency, inflation and growth shocks will keep coming back.Govt can try to induce growth with fiscal deficits. But given that we are a consumption driven economy, the govt effort leads to even higher trade deficits, inflation and currency fluctuations.And as govt tries to give a boost to a economy slowing because of inherent constraints and external issues, the next crisis becomes bigger.
Have a look at what happened in 2008 and later. The fiscal deficit went from the range of Rs.2 lac cr. before 2008 to more than 4 lac cr. And now this year it threatens to cross 5 lac cr. if we include the various subsidies being doled out.Inflation has been close to double digits for almost 2 years now even though we have not passed the full effect of the crude oil prices.
Rupee is back to 50 to the USD even before FIIs have sold anything substantial in the stock market.This is very unlike 2008 when Rupee did touch 50-52 to the USD, but after a heavy bout of selling by the FIIs.
(That does not necessarily mean that FIIs are going to turn big sellers in the Indian market, but I am just trying to say that the nature of the problem is more serious than it was in 2008.Or at least that is my feeling right now)

Agriculture - We are facing stagnant per capita availability in most agricultural products (except a few). In some cases the per capita availability is going down. This is happening at a time when the per capita incomes are going up. The resultant increase demand for basic cereals and proteins is pushing agri-inflation.As of now this looks like a structural issue, with the agricultural growth not keeping pace with rising incomes and the ancillary infrastructure around agriculture proving to be a bottleneck.Double digit food inflation for two consecutive years has already spilled over to higher wages.

Having put up this argument, it does come to mind that even China imports a lot of what it needs. But they have been able to avoid at least some of these issues.
Its true China imports a lot of the commodities, but I think there are some other differences when compared to India that helps it avoid these issues.

- Firstly consumption as a % of GDP is almost half in China. So they end up exporting a lot of what they import, which is reflected in their trade surplus.So they have current account surpluses instead of deficits. And thus their dependence on capital inflows is much lesser. In fact the trade surpluses can attract more capital in hope of taking advantage of a stronger currency. That this dependence on exports creates other issues is a different matter altogether.

- Secondly the massive infrastructure that they managed to build, a big chunk of which came in the 1990s and early 2000s when commodities were running at their lowest prices in decades.

 
- Thirdly productivity of almost all factors is higher in china except probably capital. It is routinely mentioned that India uses its savings much better.But China has used the capital to put up infrastructure which by definition is “low RoCE”. So they may have used capital a little less efficiently but then they have comparatively lesser inflation and bigger trade numbers.What we save on capital, we pay back I suppose by higher inflation and deficit problems.

Agriculture is probably the common place where both the countries face the same issues. Thus that part of the inflation is common to both.

Looking at at this very basic analysis, I would think there is a big fallacy with the Indian consumption led growth story. 

"We are wanting to consume much more that what we can produce"


What can change around the scenario:
- Collapse in global commodity prices, without having a big effect on the Indian export driven part of the economy. 
- Huge productivity improvements and removal of bottlenecks. (Basically taking advantage of the low hanging fruit)


I am not being critical of anyone, but just trying to put this as an neutral observer.

As of now, I think we would need to accept lower growth till we fix the systems or the commodity scenario changes. Slower growth is surely not acceptable to anyone. 

In that case it looks likely that markets will enforce lower growth on us through inflation and currency. That will be much more painful than a self-controlled slowdown.


There is a famous Indian axiom:
"Chaadar jitnee lambi ho, pair utne hi failaao".


But it is also true that a crisis is also an opportunity.

On that cautious note, I wish all a very Happy Diwali. And I hope everybody has a prosperous, happy and healthy New Year!!