Beating the forecasts

Forecasting the growth of the Indian economy has become a hazardous business. The numbers for the first quarter of 2006-07, released late last week, beat even the most optimistic forecasts and had GDP growing at 8.9 per cent over the corresponding quarter of the previous year, which itself had shown a growth rate of 8.5 per cent over the first quarter of 2004-05. While government agencies do not publish quarter-on-quarter growth forecasts, it is clear that they are systematically under-predicting growth. Mr Chidambaram went on record a few weeks ago saying that he expected growth during the quarter to be above 7 per cent, which was a no-brainer. The Reserve Bank of India still sees growth for the year in the 7.5-8 per cent range, which it believes is consistent with a 5-5.5 per cent inflation rate. It will almost certainly have to change its view on the sustainable growth-inflation combination, particularly in the light of the recent softening in oil prices. It is not that private forecasters are doing much better. The consensus for the first quarter was well below what has turned out to be the case, and no one had predicted even 8.5 per cent.

Where has the growth come from? In the services sector, the trade, transport, hotels and communication segments, accounting for more than half of overall services and more than a quarter of GDP, grew by 13.2 per cent, up from 11.7 per cent last year. Manufacturing, accounting for about 16 per cent of GDP, grew by 11.3 per cent, up from 10.7 per cent last year. Most other components, including agriculture, grew at close to last year's rates. The two segments which saw noticeable declines were electricity, gas and water, which went from 7.4 per cent last year to 5.4 per cent this year, and construction, which declined from 12.4 per cent to 9.5 per cent. At the level of these aggregates, it is clear that the growth momentum is quite broad-based across industry and a variety of services, which augurs well for sustainability.

Why is the forecasting community underestimating the capacity of the economy to grow? The answer probably has something to do with the role of historical data in the forecasting models used. If so, significant technological change is called for; to the extent that policy decisions are made on the basis of these forecasts, errors in the latter will very likely result in wrong turns in the former. More importantly, how is growth being sustained, even accelerated, in the face of such obvious constraints in infrastructure (note the slowdown in the power sector), not to mention the challenges that the ruling coalition faces in charting its economic policies? Perhaps the constraints are not as binding as they appear to be, and considerable innovation and investment are going into finding ways around them. This may be a costly waste from a social welfare perspective, but it helps to keep the momentum going. As far as economic policy is concerned, this growth performance is one more piece of evidence that unshackling private enterprise will make a vital difference to growth and development.