Why India can’t run much faster in 2018.
Blaring titles like "Boom Shaka-laka", Wall Street forecasters are
predicting that the global growth surge of 2017 will roll on next year.
And they expect India to crash the party, finally.
Though it was the only major economy that didn't accelerate in 2017,
thanks to its own policy mistakes, India is a consensus pick to gain
speed in 2018.
That's possible. India's economy has long tended to move in sync with
the rest of the world, and it fell out of step last year largely because
it was tripped up by the poorly designed GST, and the unorthodox
demonetisation scheme. As those self-inflicted shocks fade, India should
fall back in step, but for one big caveat.
Forecasters hyping a return to the 1990s and another "Goldilocks" age
of high growth and low inflation in the global economy may be too
optimistic. Several key economic trends are peaking worldwide, which
means that India could jump back on the global economic bandwagon just
as its growth rate may be about to lose momentum.
The big change since the Goldilocks era of the 1990s is demographics.
The world's capacity to generate economic growth is in good part a
function of how many people are entering the workforce, and over the
past decade a sharp fall in working age population growth has shaved a
full point off the world's growth potential, dropping it to around 2.5%.
The global economy just had its best year in a decade, with growth
accelerating past 3%. Already then, growth is running hot, well above
its new, significantly reduced potential. The world economy is thus much
more likely to fall back than to accelerate next year. Sustaining a
growth rate above 3% was feasible in the 1990s, when more young people
were entering the global workforce, but not in 2018.
A dwindling workforce also puts upward pressure on wages, which will
eventually spillover into higher inflation. That didn't happen last
year, but the pressure continues to build. A global unemployment rate
calculated by JP Morgan since 2000 is down to 5.6%, tying its previous
low. From the United States to Germany, Japan and Britain, unemployment
in developed economies has fallen into single digits—lows last hit in
the 1990s, or earlier.
In short, with economic growth and employment peaking across the
globe, growth is likely to slow in 2018 while rising wage pressure
finally pushes up inflation. Central banks across the world are now
acknowledging these boom-like conditions and gradually stepping back
from their post-crisis easy money policies. The US Federal Reserve
and the People's Bank of China are already raising interest rates and
could be joined by more central banks next year. If the rest of the
world starts to lose speed as a result of these tighter policies, it is
less likely India's growth rate will accelerate much beyond its current
Moreover, even if the world economy does not slow, India faces a
second series of constraining peaks in the domestic economy. Since 2013,
India has made big strides reining in past excesses. The deficit in the
current account, a measure of trade and financial flows that shows how
heavily a country relies on foreigners to finance its spending habits,
fell from nearly 5% of GDP — a risky level — to a low of less than 1%.
The central government deficit, a symptom of the chronically spendthrift
bureaucracy, came down from 5 to 3.5%. And inflation, which reflects in
part weak investment and overconsumption, plummeted from double digits
to below 4%.
Now, the progress on all these three key macro variables has peaked,
and possibly turning for the worse. Higher prices for oil and other
imports are leading to a widening of the current account deficit. Though
the government expects its fiscal deficit to continue falling, there
are reasons to think it won't.
GST was designed to streamline the tax system while raising revenue,
but appears to be falling short on the revenue side. While the
government deserves credit for bringing more discipline to public
spending, there are signs that it is slipping back into populism,
offering giveaways and subsidies to the beleaguered rural sector. And
the temptation to indulge in populist spending will only grow in the
run-up to the national elections in early 2019.
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