Subir Gokarn: Resurgence, resilience and resistance

It is possible to favourably balance growth, stability, and welfare within the reform blueprint

The GDP growth numbers for the second quarter of 2004-05 say the economy grew by 6.6 per cent during those three months. For the same period last year, the new year's eve gift to the nation was growth of 8.2 per cent, on the back of a 10.2 per cent surge in agriculture.

Virtually the entire difference between the two years is the up-and-down performance of agriculture, which declined by 0.8 per cent this year.

That was expected, and is not the main story. The most significant aspect of the second quarter performance is the robustness of the non-agricultural sectors.

Industry grew at over 7 per cent, and manufacturing, its largest component, touched 8 per cent. Services maintained their 8 per cent record, a number, which rapidly appears to be becoming a trend.

Take agriculture, both positive and negative, out of the equation and we are likely to have two successive years of 7 per cent plus growth.

The factors underlying this resurgence after a long period of sluggishness in industry have been discussed extensively, but are worth a brief recap.

The two critical drivers of the recovery that began in 2002 were the dramatic decline in interest rates and the significant turnaround in public investment through the road development programmes.

Low interest rates fuelled the housing, automobile and consumer durable booms that were instrumental to the acceleration in industry. Although the momentum in these sectors has slowed somewhat, because the drivers themselves have plateaued, they still continue to provide ballast to the process.

Over the last year, the leading role has been taken over by the machinery and equipment sector, indicating a drive towards capacity expansion by industry, the first broad-based upturn in private sector investment activity since the mid-1990s.

The great thing about an investment-led recovery is that it indicates optimism about medium and long-term outlooks on the part of investors.

The problem with it is that sooner or later, people will decide that enough is enough as far as additional capacity goes, so it can just stop dead, thus precipitating a downturn. But, that is something we don't need to worry about just now.

What makes the positive performance this year even more striking is the fact that it has been a particularly turbulent year as far as both domestic and international upheavals are concerned.

We had a political outcome that created a lot of uncertainty about policy continuity. To the extent that the two key drivers of the recovery were directly attributable to favourable policy changes, expectations of maintaining both direction and the rate of change were critical to sustaining the momentum in investment activity.

Whatever view one may take of the state of the policy consensus, the numbers tell their own story. There is no evidence of a post-election slowdown in investment. The momentum, at least for now, appears to be politics-proof.

Then, the monsoons turned up deficient, leaving the country with a 13 per cent shortfall for the season as a whole, but, more critically, 19 per cent in the month of July.

This is showing its first impact on the economy in the form of the slight decline in agricultural GDP during the second quarter and will undoubtedly have a far more significant negative impact in the third.

However, the important thing is that this factor appears to have had little or no impact on industrial and service sector performance. We cannot say definitively that the non-agricultural economy has become monsoon-proof, but the experiences of both 2002 and 2004 suggest that it is well on its way to being so.

Finally, we had the third oil shock, at the peak of which crude prices, in real terms, were only about 15 per cent lower than the all-time high of January 1981. They have declined from that level since, but are still high in comparison with the relatively benign record of the 1990s.

So far, both the world economy in general and India in particular have not manifested the kind of adverse reaction we saw during the two previous episodes, despite comparable levels of real oil prices.

Despite increasing energy intensity, Indian producers seem to be able to absorb this shock with a far greater degree of equanimity than before.

This resilience in the midst of resurgence is not happenstance, good fortune or the result of benign stellar positions. It is the outcome of the entire cumulative sequence of reforms.

The increasing efficiency and competitiveness of domestic producers, unconstrained access to imports and an effectively deregulated interest rate regime are all critical contributors to both the growth acceleration of the past two years and a stable macro-economy with an effective shock absorption capacity.

Over the last year, there has been a widening academic and policy debate around the question of whether the reforms initiated in 1991 have contributed to the acceleration of growth or not.

The main evidence presented by people who argue that they haven't is that the average growth performance of the post-reform period is not significantly different from the decade prior.

While the debate continues, one must emphasise that there is likely to be far less controversy about an inference that the reform measures have contributed enormously to macroeconomic stability without adversely affecting growth performance.

The question being debated is fundamental to the future course of policy. If the reforms so far have yielded a growth plus stability outcome superior to what preceded it, have they done their job and is there a need to upset any more apple-carts?

It is extremely comforting and, therefore, enormously tempting to bring a disruptive and unpredictable process of change to a halt. Probably, the most commonly used phrase in policy discourse in recent months is "ruling out" reform measures that are fully consistent with the overall strategy as it has played out so far, including privatisation and labour reforms.

This signals resistance to continuing down a path that could well settle the debate by providing superior outcomes on both the growth and stability fronts.

It is one thing to supplement a reform strategy with mechanisms that either increase access to new opportunities or provide safety nets to those who are hurt in the process.

Properly done, this would add the critical dimension of welfare to the other two objectives of growth and stability. But, to do this, it must first be recognised that it is possible to favourably balance growth, stability and welfare within the existing reform blueprint.

Without this, growth and welfare can, and are, being seen as mutually antagonistic objectives. That, unfortunately, will, sooner or later, stop the resurgence and weaken the resilience.

(The author is chief economist, Crisil. The views expressed here are personal)