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India: fast growth does not mean a strong economy

By Derek Scissors - posted Thursday, 23 September 2010


The government’s response to painfully high prices has been to pretend they will go away soon. In autumn 2009, the government claimed that consumer inflation would dampen before spring 2010. Instead, wholesale inflation joined consumer inflation in double digits. In February 2010, Prime Minister Manmohan Singh indicated the worst was over, a claim later echoed by Finance Minister Pranab Mukherjee and others. This also turned out to be false.

The failed promises have continued for almost a year. Eventually, the government will be right - but only because a higher base from the previous year will cause inflation to fall. Lesser amounts of inflation still mean that prices are rising, and rising from a far higher base. Substantial inflation can be anticipated for some time because monetary policy, in the form of the large and negative real interest rates, continues to be so irresponsible.

Finally, the situation may be worse than it appears. Incomparable inflation indicators - weekly wholesale prices versus monthly consumer prices and so on - lead to confusion. The recent GDP announcement originally contained a sizable error due to an incorrect price comparison. It is possible that the most important inflation measurement, the GDP deflator, has been persistently underestimated in the reform era. If so, real GDP growth, which is corrected for inflation using the GDP deflator, has been overestimated for nearly two decades.

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Indian GDP adjusted for purchasing power is fourth-largest in the world, more than three times nominal GDP. But the adjustment for purchasing power is going to shrink - and measures of the economy with it - due to Indian inflation being much higher than the rest of the world’s. This is another sense in which real income growth is being exaggerated.

The US can help

The Indian government has opted for high growth and high inflation. There are other paths featuring market-oriented reform rather than hyper-stimulus that would yield high growth without the inflation tax.

There was lost opportunity to use the recent telecom bandwidth auction not to maximise government revenue but to promote quality, jobs, and growth in a critical industry. A much broader step that still can be taken is to end government discretion to seize land by assigning specific and transparent rural property rights. In 1980s China, this produced high growth and poverty alleviation. It could do the same for India.

Inflation, government waste, and other failures should be enough to convince India to turn away from state-led development. If India resumes in earnest the market-oriented reforms begun to such great effect in 1991, the US can help in the following ways:

  • the Departments of State and Agriculture should offer in the US-India agriculture dialogue technical assistance in promoting rural property rights;
  • the new India-US Financial and Economic Partnership should focus on co-operation in unwinding mutual fiscal and monetary stimulus; and
  • the US should refrain from its own intervention in US-India commerce, such as recent congressional action to target visas for Indian workers.

Not a sign of prowess

India’s present growth is not a sign of economic prowess; it is a choice most countries do not make because the concurrent high inflation typically targets the poor.

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First published by The Heritage Foundation on September 7, 2010.



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About the Author

Derek Scissors, PhD, is Research Fellow in Asia Economic Policy in the Asian Studies Center at The Heritage Foundation in the United States.

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Creative Commons LicenseThis work is licensed under a Creative Commons License.

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