It can no longer be disputed that the Indian economy is on a downturn. The IIP number released for March clearly shows that the growth cycle has slowed down. This should cause concern. While we started off the year with expectations of 8.5 per cent growth, it has diminished to 6.9 per cent, which may also be a challenge going by present trends.

Why has this happened? Couldn't something have been done?

And what lies ahead?

The slowdown in growth is palpable on the industrial front. Demand has been slack in FY12 on account of a variety of reasons. High inflation has eroded income which has caused household spending to be diverted more for maintenance consumption thus affecting demand for other industrial goods.

Meanwhile, investment has been affected by high interest rates which again we haven't come to grips with. With the Reserve Bank (RBI) relentlessly increasing interest rates, the cost of borrowing rose to around 12 per cent for best borrowers and 16-20 per cent for others. This has made investment unviable in the short run. Not surprisingly, infrastructure is most affected. Committing funds at this rate cannot be a sound proposition.

The government is unable to spend on projects because its deficit overshot by around 1.3 per cent of GDP in FY12. Government is the only entity which can borrow money relatively cheap at around 8.5 per cent. But government has little control over the deficit given that its revenue is dependent on growth. If industry and the economy do not grow, revenue collections tend to take a hit.

At the same time, most government expenditure is committed. For example, while we may be ideologically against subsidies, it is the role of government to spend where others do not. The rising price of oil added to problems. With inflation reigning at around 10 per cent for most of the year, it would have been very bold to increase prices of such fuel products as diesel or kerosene. With demand being slack, it has affected growth significantly. The result can be seen in low expectation of GDP growth in FY12.

Could anything have been done about it?

This is a tough question. The entire edifice of growth is built on inflation being under control. High inflation necessarily means use of aggressive policy measures which thwart growth. Apropos inflation, itself, we may not have been doing the right thing.

To begin with, food inflation is high notwithstanding high crop production because of two factors. Firstly, we have not paid attention to logistics thus making wastage a rule. Prices of horticulture have increased on this score. Secondly, we have used a flawed MSP (Minimum Support Price) scheme whereby the government increases the support prices of all crops every year. This increase has been around 10-20 per cent on an annual basis for the past five years, which means prices have gone up by almost 80-90 per cent across the board.

MSP is effective for rice and wheat where public procurement takes place. But in case of others, market benchmark prices increase whenever MSP is raised. This has led to high food inflation at a time of surplus production. Also, with an open procurement scheme, Food Corporation of India (FCI) is the largest hoarder of foodgrains as it procures and stores them, leading to scarcity in the market.

Therefore, with such a flawed scheme, which is justified on grounds of providing better income for farmers, inflation becomes self-fulfilling. Every year, inflation rises as MSPs adjust farmer incomes; this in itself generates the next round in the following year. So long inflation is high, the RBI has to maintain a conservative monetary policy stance, which makes it hard to lower interest rates.

And when it comes to fuel prices, the government is in a quandary. By subsidizing fuel products, the scope for spending on projects has diminished. On the other hand, any adjustment in these prices has an impact on inflation which was high already. Therefore, this is one area where one can empathize with government because oil is an extraneous factor which offers difficult options. To top it, the entire rupee took a beating as the current account widened and FII funds dried up.

This again had an inflationary impact.

What was the external scene like? The RBI has tried to make things easier for corporates by allowing them to borrow more from international markets. This has benefitted companies in the higher echelon. Rates become less competitive when a company does not have good rating in the global financial market. One must remember that liquidity has been an issue in the market because banks have been borrowing over Rs 1 lakh crore on a daily basis from the repo window. Therefore, fund availability and its cost were challenges.

At the same time, the global slowdown and subsequent quantitative easing has led to flow of funds to emerging markets. GAAR came in the way of FII funds which have caused some reconsideration. Therefore, even balance of payments came under pressure with widening current account deficit and inadequate capital flows which took its toll on the rupee.

What does the future look like?

It is difficult to be sanguine. Mostly, we need to figure whether any of these issues will be addressed now. The short answer is, I don't know. Inflation is high. Any relief looks like a statistical mirage of high base yielding a lower inflation rate. Moreover, monsoons no longer bring certainty. The link between good monsoon and harvest and prices has gotten severed. The hope is that if inflation does not further rise, the RBI may lower rates some more, since the new accepted inflation norm is 6-6.5 per cent and not 4-5 per cent as it was two years ago. This can be a trigger.

The government could also look at some reforms related to taxation or perhaps land and mining which can provide a boost to sentiment. These are relatively low hanging fruits that can swell confidence and lead to higher investment. Government embarking on projects will help and proposals for more tax-free infra bonds will provide a fillip. Rationalized fuel prices can assist too, but one is not sure a tough stance can be taken given the current inflation levels. In any event, all this will take time, and there can only be incremental progress here.

One hope is that things cannot become worse and may, therefore, get better. But this will at best reflect status quo or marginal improvement. One wishes the global situation does not deteriorate -- both economically as far as Eurozone is concerned as exchange rates get distorted, and politically via the Iranian impasse on the atomic issue.

Internally, on the other hand, the government should try hard to maintain the deficit. Deficit can be heavily destabilizing as the entire structure of future growth depends on all the following numbers being achieved -- disinvestment, subsidies, spectrum sale and, above all, tax revenue.