Indian policy attention must shift from cyclical challenges to structural
As India’s new government gets into its groove, it will inevitably be the recipient of a lot of advice on the economic agenda for a third term. Given the unfinished work on many fronts, it’s reasonable to expect policymakers to receive a laundry list of needed reforms across a multitude of sectors. But, in contrast to expansive lists, state capacity and political capital are typically much more limited.
The challenge, therefore, is to identify which reforms to spend political capital on, and, equally, how to sequence them. To do this, however, one must first identify what the binding macroeconomic constraint to higher growth currently is. Back in 2011-12, it was clear what the constraints were.
The economy was overheating, reflected in an unsustainable current account deficit (CAD) and stubbornly elevated core inflation. The need of the hour was to temporarily tame demand—through tighter fiscal and monetary policy—and buy time to fix the supply side more durably. Since then, policymakers have doggedly pursued the latter, cleaning up the banking system, introducing a bankruptcy law, ensuring the housing sector is better regulated and making infrastructure an urgent priority.
Simultaneously, macroeconomic stability has been institutionalized. An inflation-targeting regime has ensured monetary policy is more rule-based, a goods and services tax (GST) has begun to pay dividends on the fiscal front, and a war chest of accumulated forex reserves has provided buffers to withstand global shocks. Many of these actions have already borne fruit.
Bank balance sheets are the healthiest in a decade and credit is flowing again. The housing sector has begun to flourish, albeit driven by the upper end. Combined tax as a proportion of GDP
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