Is the central bank right when it points out that interest rates explain just a third or so of the slowdown in investment levels over the past few years and puts the blame for the rest at the door of ‘policy paralysis’, shorthand for Bills not getting passed and decisions not getting taken, among others? Or is the finance minister right when he rejects policy paralysis as a reason for slowing growth? A paper by two IMF staffers comes out on the central bank’s side when it tries to quantify the impact of ‘uncertainty’ and says that just around half of India’s investment slowdown can be explained in terms of conventional models that factor in interest rates and global GDP growth—it also argues, using this model, that what matters is real interest rates, not nominal ones. According to the model, a 30-point reduction in the NCAER business confidence between FY11 and FY13 in itself explains a 2 percentage point fall in investment levels.
It would be a brave man that didn’t take into account the role of animal spirits in determining investments, so it can be no one’s case that the current atmosphere doesn’t affect investment. If the government can’t take even a decision on bringing gas prices to market levels without it becoming an election issue, it is going to affect sentiments. The IMF staffers’ Policy Uncertainty Index is interesting since it accounts for what newspapers are writing as well—this is 2/3 of the index. That is intuitively obvious since, at the time when newspapers are talking of one scam after another, governments tend to be that much more cautious about making decisions and that affects investment.
It is difficult, however, to believe that global factors have not played a major role, right from the US government teetering on the brink of closure till even last year, to Europe looking like it was going to implode a year ago, and now China’s shadow banking system playing the spoiler. Yet, the regression analysis underplays the role of global factors. If rejecting the policy paralysis argument is one
extreme, this is the other.