Akash Prakash: The growth debate

Many of our constraints, be they fiscal, infrastructure or flawed policy, are going away, and the growth potential exists.

There seems to be a lot of debate among policy makers and market participants on the likely growth trajectory of the Indian economy over the coming decade. On the one hand, most academics and trained economists seem to dismiss notions of India being on a growth trajectory of anything higher than 6.5-7% over the coming decade. All the talk of a trend rate of growth higher than this 6.5% (8% or even 9%) is considered wide-eyed dreaming by incurable optimists unable to distinguish between trend growth and the peak of a business cycle. Most of these economists are convinced that anyone believing in Indian growth exceeding 6.5-7% over the coming decade is in for serious disappointment.

On the flip side are mostly businessman and market participants who are convinced that all notions of trend growth have to be revised. India has tipped and broken out. We as a country are undergoing a paradigm shift and backward-looking historical data are not relevant when judging the future. Just as no trained economist or academician predicted four years of 8% plus growth ahead for the Indian economy back in 2003, these people are missing the growth acceleration once again.

This debate is of critical importance for the future of the markets, for the difference between a decade of 6.5% growth and 8-8.5% is huge for both the economy and corporate profitability. It is also the difference between what is already priced in and a positive surprise. I would wager that most people have built 6.5% growth into their forecasts and thus this would cause no upgrades to either corporate earnings or revenue. Most people, however, are still scared to accept the 8% plus scenario, lest they be proven badly wrong and get burned again.

Let us try and understand both sides of the argument.

The growth realists argue three basic points (to my mind at least). They first of all make the argument that to grow at 8% plus, we as a country would need an investment rate of approximately 36% (assuming an incremental capital-output ratio of around 4-4.25). Assuming that we do not feel comfortable running a current account deficit of over 2-3%, domestic savings have to be in the region of 33-34% (latest estimates indicate savings are at 29%). These economists do not see an easy path to this higher level of savings in the short term, given the constraints on public savings and the long-tailed impact of demographics.

Secondly, they make the point that between 1980 and 2006, trend growth (defined as the latest 10-year average) has improved from 3.5% to nearly 7%, and to expect a further acceleration to above 8% so quickly is unlikely. It took 25 years of momentous changes in our economy and policy framework to move trend from 3.5 to 7%; how can it suddenly move to beyond 8%? Trend growth rates do not turn on a dime.

Thirdly, many economists point to the oft-neglected role of merchandise exports in boosting current growth rates. The last three years have seen strong global growth and trade expansion, which may not sustain on the same trajectory.

Another valid criticism is that since the government is following pro-cyclical policies, they are artificially super charging short-term growth or borrowing growth from the future, so to speak.

The economic bulls have more anecdotal arguments. They point to the fact that in most of the Asian economies, the demographic transition India is about to undergo has added at least a full percentage point to GDP. As infrastructure improves, as it inevitably will, this will add another point to growth as frictional costs in the economy will come down. As agriculture becomes an even smaller part of the economy, sheer arithmetic will allow growth to accelerate. Exports (both goods and services) are growing at 25-30%, and as they become a larger part of the economy growth will get a boost. The bulls also point to the micro reality that corporate India has never been more competitive or confident. Most of the big-ticket investments being planned are still to kick in and sectors like realty (with huge multiplier effects) are undergoing huge investment booms. Imagine the impact of RIL doubling the country's gas production on GoI revenue, petroleum subsidy and value addition across the economy as it replaces more costly fuel. The multiplier effects of producing 3 million cars by 2010, the entry of organised retail dropping consumer prices by 10% and having pithead ultra mega power plants producing electricity at less than Rs 2 per unit, will flow through the whole economy. How much will farmers' incomes increase with the disintermediation of middlemen by the likes of Bharati or Reliance and a hike in yields? The improvement in logistics enabled through the NHAI programme can have what type of an impact. As telecom penetration improves in rural India, how will this boost rural productivity and incomes? Tax reform through GST and VAT will have huge impacts on rationalising trade, boosting revenue and allowing India to join the global supply chain. One can go on giving example after example at a micro level. The fact is that we were growing at 6.5% before all this; so with all these improvements in productivity and reduction in frictional costs how can growth not accelerate further?

As for my own belief, I have more sympathy with the optimists, and I do genuinely believe that we are changing orbit. I have never in 15 years seen the type of changes in scale, competitiveness and ambition that one sees in corporate India today. Many of our constraints, be they fiscal, infrastructure or flawed policy, are going away, and frankly the growth potential exists.

As for what can hold us back, I would highlight two issues.

The RBI may not believe this growth acceleration story, and in its desire to cool down its perception of an overheated economy, it may become overzealous in hiking rates.

Secondly I would point to the worrying political rhetoric coming out of the UPA government on reservations, minorities and all sorts of other political hot buttons. This may cause serious social and political turmoil, which can torpedo all hopes of 8% growth. Hopefully calmer voices will prevail on all sides of the political spectrum.

Each investor will have to decide where he or she stands on the growth issue; it is one of the bigger calls each one of us will have to make.