8% tough on global mkt crisis, high deficit: Rakesh Mohan

The latest GDP data indicates that the Indian economy is growing at it's slowest pace in nine years. The annual pace of 6.5% for FY12 is slower than even Lehman's annual rate of 6.9%. Some experts like Ruchir Sharma of Morgan Stanley say that India grew at 3.5% till the 1980s. A slew of reforms, like the abolition of licensing, the cut in tariffs from 150% to 15% and deregulation of interest rates, pushed growth to the 6% mark in the 1990s.

The 8-9% growth from 2003 to 2009, say experts, was entirely because of the flow of cheap capital from the West. When that capital disappeared, India slipped back to its potential growth rate of 6%.

Academically, potential growth is measured as a function of inflation and employment. From the employment perspective, potential growth is defined as the non-accelerating inflation rate of unemployment or NAIRU.

What this means is that when unemployment falls below a certain rate like 5% for the US, inflation begins to rise because workers demand more money and that causes an upward spiral in prices. Measuring potential growth for India from the employment perspective is difficult because we don’t have labour statistics.

So let us see if we can arrive at potential growth from the GDP perspective. Experts say the pace at which an economy can grow without raising inflation beyond the economy's tolerance, is its potential growth. In India, 5% has been accepted as the inflation-tolerance level. From 2003-2008, growth touched 8% with inflation at less than 5%. But since then inflation has shot up.

According to the RBI's latest document, India's inflation is surging even as the economy grows at 7.5%. So is the economy's potential 7%? Was 8% an aberration? What should the new set of reforms be that can put growth back to 8%? The answers to these questions is crucial for central bankers, investors, corporate India and indeed the aam aadmi.

This is the debate on this edition of Indianomics on CNBC-TV18. Former RBI deputy governor and economist, Rakesh Mohan offers his perspectives on the debate and throws light on issues most crucial to the economy.

Below is an edited transcript of the interview. Also watch the accompanying videos.

Q: Would you subscribe to the view that India's potential growth is really not 8-9%. That it was a result of global factors and is an aberration?

I don't really believe that. This is clearly a short-term problem right now. I also don't believe that because gross domestic savings continue to be around 32%. If sustainable current account deficit returns to around 2%, there is still a reasonable possibility of sustaining a gross domestic savings and gross domestic investment of 32-36%.

If the economy is able, in the medium-term, to sustain a gross domestic investment rate of 35-36%, there is no reason why the economy can’t grow at 8-9% in the medium-to-long term.

Q: The parameters that you have mentioned, savings and the investment rate, have been falling consecutively for the past four years annually by 1-1.5% and simultaneously the fiscal deficit has been at 2% for almost half a decade from 2008, when it jumped to nearly 4% and has thereafter climbed to 6.8%.  It has not come down below 5.5%. So is this likely to be achieved?

That is the nub of the problem. The increase in the revenue deficit has reduced public sector savings by 3% which has obviously led to higher government borrowing. If you compare government borrowing in 2011-2012 and projected borrowing for 2012-2013 with the money borrowed in 2007-2008, government borrowing has increased by a large quantum.

Now that has had two effects - one of course, is the quantitative effect of crowding out the private sector from borrowing and raising capital. The second is that it has affected interest rates. So I do agree that the key lies in bringing the fiscal deficit under control. I don't see any reason why it can't be done again. However, it entails taking strong decisions on curbing unnecessary subsidies.