Abheek Barua: Will the current growth rate stay?

If the numbers aren't dodgy, what could have nudged this year's savings rate to 34 per cent.

India's growth momentum seems all set to sustain, at least in the short run. GDP in the second quarter of this grew by 9.2 per cent and there is nothing to suggest that things are slowing down. In fact, with oil prices coming off and both US and domestic interest rates coming down, I wouldn't be surprised if there was a mild acceleration in the second half of the current fiscal. This means that 2006-07 could end the year with an aggregate growth rate of close to 9 per cent, about a percentage and a half points above the consensus forecast at the beginning of the year.

This time, there are hardly any sceptics who question the veracity of the growth data. Take any micro indicator, be it hotel occupancy or motorcycle sales and you are likely to find that they endorse the aggregate growth numbers. Does this constitute a permanent break in the growth trend? I do not have a pat answer. There certainly seems to have been a marked change in the pattern of growth and its nuances, which deserve attention.

Let me try and do a quick review of what I see as the critical changes. For one, agriculture has ceased to matter much for overall growth. (The above 9 per cent second-quarter growth came on the back of 1.7 per cent growth in the farm sector.) I don't mean this is a trivial accounting issue. The linkages between the Indian agricultural economy and the industrial and sector sectors seem to be getting weaker. One of the links between the non-farm and farm economies historically has been through demand""Indian farmers have traditionally constituted an important demand-base for industrial products and a plethora of services. The fact that slow growth in agricultural incomes isn't hurting demand for the sectors could have interesting implications for the future.

It could, for instance, mean that there is significant income diversification within farm households where some family members bring in non-agricultural income. Thus, despite poor growth in agriculture in a particular year, demand doesn't shrink substantially. This helps "consumption smoothing". If indeed the trajectories of these alternative income streams and agriculture are significantly independent, it could lend a greater degree of stability to rural demand despite continuing volatility in agriculture. This could shore up growth rates even in the absence of dramatic structural changes in the farm sector.

Let me turn to the other feature of current growth I see as key""the rising role of goods or merchandise exports in driving the growth momentum. Back-of-the-envelope calculations for the last three years show that roughly 21 per cent of the rise in GDP was accounted for by merchandise exports alone. My sense is that neither the role of this driver nor the risks stemming from it have been adequately recognised. There seems to be a tendency among analysts to attribute the entire spurt in growth to a domestic consumption boom followed by a capex-led investment revival. The role of service exports, particularly IT, has been, on the other hand, over-hyped.

Let me turn to the risks associated with this. If current data coming out of the US are anything to go by (the Institute of Supply Manager's Index actually showed a contraction in manufacturing output in November), the slowdown in the US economy might be worse next year than anticipated. This is bound to have a knock-on effect on its trading partners, particularly the export houses of East and North Asia, including China.

Let's get a couple of things straight. Both Asia and the US are key trading partners for us for both goods and services. If demand in these economies softens, Indian exports are likely to be affected and this could have a significant impact on growth. There is a view that despite our heavy dependence on the US markets for our IT exports, a slowdown is, perversely enough, beneficial for us. The argument is that as the US bottom line begins to shrink, the need to "offshore" will actually increase. My friends in the IT sector don't quite endorse that view entirely. Quite a bit of US company expenditure on IT is purely discretionary and firms are likely to go easy on this if things get a little rough. Our IT exports will be hurt if the US loses traction.

Finally, if there is a quantum jump in growth, it has to mean a change in the pattern of financing. Simple growth arithmetic suggests that with an incremental capital-output ratio of around 4, the effective investment rate in the economy has to be around 36 per cent this year if we clock 9 per cent. These investments would be funded from the current account deficit and domestic savings. We know that the current account deficit as a percentage of GDP is likely to be about 2 per cent this year. This means that for the current year, the effective domestic savings rate would be around 34 per cent. In 2004-05, the official estimate of the savings rate was about 29 per cent.

To be convinced about the sustainability of growth I need to understand what is driving this rise in the savings rate. Is it simply an estimation issue? Or are there deeper fundamentals? If the numbers aren't dodgy, what could have nudged this year's savings rate to 34 per cent? It couldn't have been that domestic households saved that much more since that would have led to a demand crisis. Thus, it has to be private corporate savings that account for this increase""undistributed profits and depreciation reserves, which would have jumped by at least about 4 per cent of GDP. Can this sustain itself in the medium term? Or is the current spurt a blip driven by the "un-invested" stocks of corporate savings carried forward from previous years? If the domestic savings rate goes down again, are we willing to live with a higher current account deficit to fund growth? To buy the 9 per cent growth story, I need solid answers to these questions.

The author is chief economist, ABN Amro. The views here are personal.

abheek.barua@in.abnamro.com