Macroeconomic policies, such as fiscal and monetary policies, have been unable to play an effective stabilisation role in this downturn. In general, macroeconomic stabilisation policies are expected to be countercylical policies. So when the economy is expected to slow down, the government can give a fiscal stimulus. Data shows that while in the post-crisis period we did see an expansion in the growth of government consumption expenditure, it was accompanied by a decline in public investment. Growth in gross fixed capital formation by the government fell from annual growth rates of more than 15 per cent in the pre-crisis period to 12 per cent in 2008 and 2009 and further to 5 and 6 per cent in the last two years. The main difficulty in giving a fiscal stimulus was the already high level of fiscal deficit. In the good years from 2004 to 2007 there had been no serious attempt at fiscal consolidation. If the government does not tighten its belt when times are good, then it does not have the space to give a stimulus when times are bad.
Similarly, the period of low inflation in the pre-crisis period could have been one of the best times to move to an inflation-targeting framework. The central bank could have earned credibility and low inflation. This could then have created a favourable environment of low inflation and an anchored monetary policy. Instead, in the pre-crisis years the RBI spent all its energy on preventing rupee appreciation when actually an appreciation could have been an effective countercyclical monetary policy preventing overheating and keeping the price of tradables low. This mistake proved costly once the crisis hit. High liquidity generated from years of partial sterilisation of the rupee, along with the lack of a nominal anchor and a sharp rupee depreciation, resulted in the buildup of inflationary pressures in the economy. The RBI is still grappling with the consequences of its mistakes in the pre-crisis years.
It is unlikely that the GDP growth cycle will turn around very soon. In the long run India remains a high-growth economy. However, along with high growth we may have to live with high volatility of growth and inflation unless we can adopt a credible framework for macroeconomic stabilisation policies.
The above view is rather modest in proper estimation of situation. I have dealt with the situation in a subsequent post here.