The pre-Budget Economic Survey of the government, published in late February, exudes optimism about economic growth: “Indian GDP can be expected to grow at 8.5 +/- 0.25 per cent (in 2010-11), with a full recovery breaching the 9 per cent mark in 2011-12.” In his Budget Speech, the finance minister said, “With some luck, I hope to breach the 10 per cent mark in the not-too-distant future.” Government statements at Budget time are expected to be optimistic. But it is surely time to sit up and take notice when normally hardnosed commentators like Martin Wolf write, “I have little difficulty in imagining that India can sustain growth of close to 10 per cent a year for a long time” (Financial Times, March 3, 2010). How justified is such exuberance on growth expectations?
Much of it is based on solid experience, especially the economy’s resilience during the Great Recession. In the five years up to 2007-08, India’s economic growth averaged close to 9 per cent a year. The downdraft from the global crisis certainly slowed India’s momentum in 2008-09 but much less than the overwhelming majority of international and domestic analysts (myself included) had feared back in the post-Lehman autumn of 2008. Despite dropping a shade below 6 per cent in a couple of quarters, full-year growth in 2008-09 was a surprisingly resilient 6.7 per cent, thanks largely to massive fiscal and monetary stimuli. In 2009-10, despite a fairly serious agricultural drought, overall economic growth is officially expected to exceed 7 per cent. And that’s an estimate very few would bet against. Then, with normal rainfall, what’s so difficult about growing at 8.5 per cent in fiscal 2010-11, above 9 per cent in 2011-12 and perhaps 10 per cent soon after? Well, let’s dig a little deeper.
The acceleration of India’s growth from around 6 per cent in the early years of the decade to 9 per cent by 2005-06 can be attributed to several factors. An important one must surely be the remarkable rise in the rate of aggregate investment from around 25 per cent of GDP in the early years to 35 per cent by the middle of the decade (Figure 2). This unprecedented increase in the investment rate can, in turn, be attributed to a number of interlinked causes, including a sharp increase in private corporate savings (depreciation plus retained profits) from below 4 per cent of GDP in the early years to above 8 per cent in the later years; remarkable progress in fiscal consolidation which improved governmental savings by 4-5 per cent of GDP by 2007-08; and relatively low nominal and real interest rates (Figure 3). The last feature was undoubtedly buttressed by the buoyant (pre-global financial crisis) international capital markets and the concomitant surge in foreign capital inflows into India during 2004-08.
The Great Recession and its aftermath have hurt some of these growth-friendly conditions. First, because of expansionary fiscal actions undertaken to counter recessionary forces (and increase government pay and expand entitlement programmes), India’s combined fiscal deficit (Centre and states) remained above 10 per cent of GDP in 2009-10, double the pre-crisis level of 5 per cent in 2007-08. Despite a modest deficit reduction of about 1.5 per cent of GDP projected in the Central Budget for 2010-11, government borrowing requirements will remain high at a time when the Reserve Bank of India (RBI) has begun to reverse the exceptional liquidity expansion and policy rate cuts of late 2008 and early 2009. Unsurprisingly, the yield on 10-year benchmark government bonds has hardened post-Budget. With domestic inflation high (nearly 10 per cent year on year in February as measured by the WPI and significantly higher according to partial CPI indices), there is a strong likelihood of further policy rate increases by RBI in the months ahead. So, the investment rate, which took a modest knock in 2008-09 (as did domestic savings), may not recover any time soon. It might even fall further.
Second, the strong GDP growth during the noughties was somewhat lopsided, with about two-thirds coming from services, less than 10 per cent from agriculture and the remainder from industry. Long-term sustainability requires a more balanced pattern, with higher contributions from agriculture and industry. But industry, especially manufacturing, remains burdened by poor infrastructure, rigid, anti-employment labour laws and a still complex indirect tax structure. The government has made some limited progress in tackling infrastructure constraints and the promise of an integrated goods and services tax (GST) by spring 2011 buoys hopes. However, there is no political appetite for reform of labour laws, which could unlock enormous potential in employment-intensive manufacturing and hugely enhance the inclusion of unskilled, non-farm labour in India’s development, especially in the country’s poorest states.
In the short run, the prospects for faster growth of the tradable sectors (industry, agriculture and traded services) are clouded further by the recent trend of an appreciating rupee. Between March 2009 and February 2010, the RBI’s six-currency real effective exchange rate (REER) index of the rupee has shown an appreciation of a hefty 15 per cent, partly because of an apparently novel, non-interventionist approach by RBI in the face of rebounding capital inflows. Unfortunately, this relatively new and questionable stance comes at a time when China’s renminbi remains firmly pegged to a depreciating US dollar. The exchange rate toll on tradable production will look worse as the higher inflation numbers for March, and perhaps April, feed into the REER index and bodes ill for the already high (10 per cent of GDP) merchandise trade deficit in the quarters ahead.
In the longer run, there is no denying the favourable potential for India’s growth prospects from the demographic dividend of a young population, the technological “catch-up” advantages of a relative late-comer to development and the impressive efflorescence of entrepreneurial talent. But transforming this potential into sustained high growth requires politically difficult commitments to fiscal consolidation and serious reforms of agriculture, infrastructure, labour laws, education, retail trade, energy pricing, banking and urban policy. This is especially true when the “new normal” for the global economic environment suggests slower growth of industrial countries, a rising possibility of trade frictions and uncertain energy prices.
Over the past six years, the UPA government has spent far more of its energies on expanding entitlement programmes than on economic reforms. Against that background, it may be safer to bet on medium-term economic growth of 7-8 per cent than the 9-10 per cent blithely projected by government spokespersons… and Martin Wolf.
The author is honorary professor at ICRIER and former chief economic adviser to the Government of India. Views expressed are personal
