Shankar Acharya: Seven minus Seven equals Seven?

A PIECE OF MY MIND

One of the challenges for a regular columnist is to make each title interesting or, at least, a little mysterious, in the hope that the reader will be tempted to read on. Well, this one falls in the latter category. But too much mystery could be irritating, like those ultra-subtle French films where you have to desperately look for the solution of a whodunit in the closing long-shot. (I usually remain perplexed and have to ask someone.) So, let's cut to the chase. This piece is about seven reasons which explain India's extraordinary (and largely unexpected) 8.5 per cent economic growth in the last four years and seven reasons why this may not be sustained, suggesting that medium-term (next five years) growth is more likely to average around 7 per cent.

Success, they say, has a hundred fathers. My choice of the seven factors that explain India's exceptional recent growth are as follows: the cumulative, virtuous cycles embedded in 25 years of good (6 per cent) growth; the globalisation-reaping benefits of a much more open economy; an expanding "middle class" fuelling domestic consumption; the "demographic dividends" of a young population; the rise of strong companies in a modernised capital market; lower interest rates and an improving fisc; and strong global economic growth. A few words on each of these.

India is one of a handful of developing countries which has successfully averaged over 3 per cent per year per capita growth in the quarter century since 1980. Prolonged, steady growth triggers several virtuous cycles, including, especially, incentives for higher savings and investment.

Second, all that hard policy work in the 1990s of reducing customs tariffs, phasing out import licences, moving to a market-responsive exchange rate and opening up to foreign capital has paid off handsomely in rewards from closer engagement with the world economy. Between 1990-91 and 2005-06 the ratio of foreign trade (goods) to GDP more than doubled from below 15 per cent to over 32 per cent, while the share of current receipts (goods exports plus invisibles earnings) tripled from 8 per cent of GDP to 24 per cent. Basically, exports of goods and services (including software) have boomed, creating new jobs and raising productivity.

Third, the premature (in the early 1990s) hype about a growing middle class has, with growth, become much more of a reality, underpinning sustained and strong expansion of domestic demand. According to NCAER survey estimates, the number of people in households with annual incomes of Rs 2-10 lakh has soared from around 15 million in 1990-91 to about 100 million in 2005-06. Hence the explosive growth in sales of cars, two-wheelers, TVs and, of course, cell phones.

Fourth, the much-touted "demographic dividends" of India's young population may be oversold for its labour supply bulge (in a context of slow job growth), but the rising share of working age population has brought clear dividends in the form of growing household savings, which have helped finance higher national investment.

Fifth, the legal, institutional and technological reforms of India's capital markets in the 1990s have greatly assisted the rise of strong Indian companies, especially (but by no means exclusively) in sunrise industries of infotech, telecom, media, airlines and pharma. An increasingly confident and competitive corporate sector has enhanced productivity and rapid investment growth.

Sixth, the fall in real interest rates in the early years of the decade and the more recent declines in central and state deficits have also helped to induce and nurture the investment boom since 2003.

Finally, to the surprise of many forecasters, the world economy has powered ahead at almost 5 per cent over the last four years, propelled by strong growth in the US and China and some recovery in Japan and Europe. India's now much more open economy has benefited from this global expansion.

Looking ahead, the seven key factors which are likely to constrain future growth are: renewed fiscal stress from populist policies, the perennial infrastructure bottlenecks, labour market rigidities, weak agricultural performance, slow economic reforms, weaknesses in human development programmes and a possible slackening in global growth.

With general elections just two years away and the Sixth Pay Commission in train, the momentum of populist expenditure programmes is likely to gather steam, implying risks of renewed pressure on public deficits and savings and consequent negative fall-out on investment and growth.

Second, the deficiencies in electric power, roads, water and urban infrastructure remain massive. Unless they are swiftly corrected, the Planning Commission's aspirations for 9 per cent growth in the next five years look distinctly optimistic.

Third, without significant reforms of existing labour laws, India's cheap labour advantages will remain hugely unfulfilled. Moreover, with the bulk of the demographic bulge occurring in the weakly governed, poor and slow-growing states of central and eastern India, the challenge of ensuring broad-based, job-full growth is enormous.

Fourth, despite recent data revisions, the post-1996 record of agriculture remains disappointingly weak. Given the current state of systems of irrigation and water management, research, extension and credit, it is very hard to put faith in the 4 per cent agriculture growth projections of official planners. Indeed, secularly weak agricultural performance is a key factor sharpening the growth-inflation trade-off in the current environment.

Fifth, the slowdown in economic reforms over the past three years is an unwelcome reality. If reforms yield growth dividends with a lag, then the recent "reforms pause" could exact its toll from future growth.

Sixth, and in a longer time-frame, the woeful inadequacies in our public systems of education and healthcare (at all levels) are well-known. Their costs in terms of skill development for an increasingly knowledge-driven and competitive world economy are uncertain but indubitably high in the long run.

Lastly, the "Goldilocks" global expansion of the last few years cannot be taken for granted for ever. Those lurking bears could get nasty sometime, with negative consequences for India's growth trajectory.

There you have it: the seven pluses and the seven minuses, so to speak. There is a good chance that the widely prevalent bullish expectations of 9-10 per cent growth in the medium term are overly influenced by the recent past (2003 onwards), a period of strong cyclical upswing in both the global economy and Indian industry and services. Medium-term expectations for 7 per cent growth may seem unduly cautious today, but wiser with the benefit of hindsight. Any way, I prefer to be pleasantly surprised on the upside!

The author is Honorary Professor at ICRIER and former Chief Economic Adviser to Government of India. The views expressed are personal