“India may have to bear some headwinds next year”

FORMER RBI GOVERNOR Raghuram Rajan and assistant professor of economics at Pennsylvania State University Rohit Lamba underline a policy need to look beyond centralised low-skill manufacturing and focus on ‘high-skilled service’ and ‘service embedded into manufacturing’ as an economic model for India’s growth. In a discussion around their latest book — “Breaking the Mould: Reimagining India’s Economic Future” — Rajan and Lamba touch upon global challenges to India’s growth and concerns around private capex. Edited excerpts.

It seems the global slowdown has only been deferred and not averted. Where do you see the global economy and India?

Rajan: At the beginning of the year, there were a lot of worries about the global economy, which led to worries about India. That slowdown has not taken place. Signs of the U.S. economy beginning to slow are being seen. The question is whether it will be a soft landing or a hard one. Probably, it will still be difficult to engineer a soft landing. And where the Fed goes, the world follows.

The Chinese economy has not picked up since the pandemic and Europe has slowed down considerably. India has benefited from the growth this year. But it may have to bear some headwinds next year. We have to wait and see how much it will impact India.

What are the key macro aspects we need to watch out for in the Indian context?

Rajan: FDI is slowing down considerably since 2021 and private sector investment is elusive. Even when I was the governor we would say capacity utilisation hasn’t gone up to the level where the private sector seems compelled to invest. Even today the numbers haven’t picked up. So, why is capacity utilisation not picking up and why is the private sector not investing in a big way?

Lot of growth in the first two quarters this fiscal was driven by government investment. How long can the government invest without breaking the budget? It will have to slow down in the second half. The last aspect is the issue of manufacturing vs. services. Manufacturing has grown, but services exports have been spectacular since Covid. The question is, can manufacturing exports pick up?

Is Indian growth specific to the domestic economy or is it a part of the general trend? Is Capex the only factor, or are there other contributors to growth?

Rajan: Post-pandemic period is a complicated one. We went down and had to come up. In 2019-20, the last year before the pandemic, we grew at 3.7%. It was not a good growth rate for India. During the pandemic, we came down drastically in some quarters and went up later. Average GDP growth in the last four years is about 4%.

One way to look at it is to see why we have such low inflation. If we were really growing beyond our potential of 6%, say at 7–7.5%, we should be reaching a limit where we would have seen inflation picking up. The fact that it is not picking up indicates we are still below our potential level. This catch-up growth is good. The question is, can we increase our potential?

On where growth is coming from, government spending is good. Also, global slowdown did not happen, so our imports and exports are keeping pace. We are also seeing growth catching up. The bottom line is we have to look at it over a period and not be influenced by a particular quarter of growth.

Consumption, especially in the upper end, has been spectacular since the pandemic. The lower end has not been good. It is worth watching as it is a reflection of the two-paced growth in the economy.

It is true of housing also. Upper-end housing is giving a boost and the more affordable kind is not. So the two-paced, or “K” shaped growth, is worth watching.

How much merit do you see in the argument that India did not witness runaway inflation unlike FY11 as Centre preferred credit and self-reliant economy led growth in pandemic stimulus instead of direct fiscal stimulus?

Rajan: I would not put it as fiscal spending vs. credit. Both can have the same effect of expanding the demand if you exceed potential and create inflation. I would go back to the earlier point that we created a lot of spare capacity by slowing down tremendously before the pandemic. At least, for a while, we can sustain this growth without inflation.

What would you consider the ideal potential growth rate for an economy like ours?

Rajan: Question is the difference between the aspirational level and what it is now. It is about 6% right now. We were trending down before the pandemic. Lot remains to be seen as to whether we can go up. We need the quality of growth to be better as well. We have to create more jobs per unit of GDP growth. That will require some effort.

Is there a number you would like to put to the GDP growth rate India needs?

Rajan: More is always better. You need to create capacity to grow at 7% or 7.5%. If we just do fiscal spending and borrow a lot and expand credit growth, it will generate demand, but if we don’t have the capacity to supply that, we will run very quickly into inflation.

What are the levers we can deploy to get two or three economic engines going, which in turn will push private investments?

Rajan: On the monetary side we are fine. RBI has an inflation target and it is doing what it needs to.

We have a large fiscal deficit, both Centre and states combined. There is not much we can expand. That leaves us with structural reforms. The central reform we need to do is to improve the quality of human capital because that will create demand and supply. We need to create more confident households, especially at the middle and lower end, thereby improving the employment outlook.

If private investments are not happening at a desirable level and there is a limit to government expenditure, how do we create jobs?

Rajan: There is no solution in one year. If you have a short-term framework on any solution, you are going to end up just saying let me subsidise this and that and I will get it. We need true leadership which is not looking at the next elections. If you want to become a first-world nation in 20 years, it is within your horizon. But you cannot afford to become a first-world country if 35% of kids are suffering from malnutrition and 50% of fifth graders cannot do second-grade maths. That is what you have to fix very quickly.

You mentioned structural reforms. Specifically, what reforms are needed?

Lamba: There is a China fetish in India you cannot deny, and that is in the way we think of our future. It seems there is a policy desire that a cocktail of decisive leadership and low-skilled manufacturing is the model that India should follow. We broadly disagree with that in the book. India needs to take its competitive advantages in services and services embedded in manufacturing seriously.

Manufacturing itself is changing. We should try to understand what we are good at. India is and can be even better in services embedded in manufacturing. A large part of input in modern electric cars, for example, is services — writing code. This is a service embedded in a final product. We have a headstart in this. Estimates suggest one fifth of all chip designs happens in India. While we are trying to spend ₹16,500 crore in Gujarat to set up a Micron plant, we already have a headstart in designing chips. We also seem to have a headstart in direct services and services embedded in manufacturing.

Are these the alternative models you are suggesting when you say in the book that we have to follow a truly Indian path for growth?

Rajan: We are saying that authoritarian, centralised manufacturing oriented growth may have been good for us 20 or 30 years ago. But it is difficult to replicate that path now. Even though Apple or someone else is going to come because they want China Plus One, they come in naturally. But trying to become an export super power in manufacturing, like China, is too big an ambition. One, China is not going to leave that (position) anytime soon. It still has a lot of cheap workers, and then there are a lot of China clones such as Vietnam which are there.

What do you consider as red flags in the economy? One could be freebies, but among them, are there some that are very essential?

Rajan: My benefit is your freebie, your benefit is my freebie. That’s how the political economy functions. They are all promising some version of transfer of benefit but criticising each other for freebie culture.

Lamba: Certain transfers are absolutely essential. But at some level we are all becoming prisoners of our own instruments. So what are the instruments around which people are galvanising? Government job, reservations, and more freebies. It is incumbent upon us to move the needle on what should be the instruments around which people can ask things from their government. They should be asking for public services and so on.

What should be the government’s priority for the upcoming Budget?

Rajan: We like the sentiment behind the National Education Policy (NEP). But we need to look at the regulation to make it much more transparent.

It’s time we got a university in the top 100 list. Start creating intellectual property. We are talking about the National Research Foundation. The level at which it is going to be endowed seems to be pitiably small, especially when you also want the industry to start investments in research. Education has to be a public good, especially high-quality education. Can we invest more in it?

What are the two immediate course corrections you would do?

Rajan: I have already mentioned education reforms. I would take a serious look at schools, see what has been done to bring the kids back to school and do remedial education for them.

We need to take a look at why we are not attracting China Plus One investments. Why FDI has slowed down and how we can bring in more investments.