Suman Bery: The Nine Per Cent Economy

The coming year provides an opportunity to debate critical economic choices for the next government.

If April is the cruellest month, December should perhaps be noted for contributing to clarity. The electoral outcomes in Gujarat and Himachal Pradesh have made it clear that the UPA government will not call an election in advance of the appointed date early next year. The Congress spin managers will no doubt make virtue out of this necessity, and indicate that, once more, a Congress-led government will serve out its term.

National politics (and, for that matter, economic policy) is already entering what in the US is referred to as the "silly season". This will only get worse in the months ahead. Yet, the coming year is in fact an important time for that tribe of analysts and commentators that my fellow columnist Surjit Bhalla refers to as "policy wonks".

In agencies such as the World Bank, whole work programmes are designed to prepare policy notes for an incoming government. The same is true in the think tank community in the United States. This is facilitated by the predictable timing of elections, and by the more important role of ideas in political competition between candidates. To my knowledge, an equivalent tradition is less well established here, although it is arguably more necessary given the relatively weak policy capacity in the major political parties.

It is equally unfortunate that the cycle of Five-Year Plans has now drifted so out of sync with the electoral cycle that the recently approved Eleventh Plan will in substance overlap only with the final year of the government that prepared it. The Plan is a political document, but it is also the best available summary of the state of knowledge and thinking in officialdom and in the policy community more broadly. The Plan provides a structure, a diagnosis and a framework against which to assess the major policy and programme challenges facing the government.

Accordingly, over the course of this year I intend to use these columns to examine selected topics raised by the Eleventh Plan both in the light of the diagnosis and programmes offered in the Plan document, but also in the light of parallel research and commentary, both at NCAER and elsewhere.

In the present column, the issue I wish to address is one which is more implicit than explicit in the Plan. That is the interplay between management of aggregate demand and of aggregate supply in achieving, sustaining and going beyond 9 per cent growth, to the 10 per cent that is desired and anticipated in the final years of the Plan.

By tradition and origin, Soviet-style planning has tended to focus on easing supply constraints in the economy, largely through public investment. The macroeconomic framework in each plan has accordingly tended to focus on the resources available to finance investment. These resources largely come from the domestic economy, in the form of domestic saving. But they residually also come from abroad, what economists call foreign saving, which according to the structure of the national accounts is equivalent to the current account deficit.

As is well known, the Plan projects a step-up in GDP growth from the 7.5% achieved in the Tenth Plan to an average of 9% over the period 2007-11. This increase is to be achieved through both an increase in the average investment rate and an improvement in the efficiency of investment.

Thus investment as a share of GDP is anticipated to rise from roughly 32% in the Tenth Plan (reaching an estimated 35.5% in 2006-07, the last year of the Plan) to almost 37% on average over the Eleventh Plan, and presumably rising over the life of the Plan. The increase in efficiency is represented by a reduction in the incremental capital-output ratio (ICOR) from around 4.3 to 4.1. This will take some doing with a rising investment rate and a big push to investment in infrastructure, which by its nature is long-lasting. Presumably the calculation is that, in the short run at least the rest of the economy stands to gain through elimination of bottlenecks.

What is really interesting though, is what the Eleventh Plan document projects about the balance of payments, which is the route by which foreign savings are delivered to the economy. While the average current account deficit does not differ all that much over the two plans (1.9% as versus 1.3%), the differences are much more significant at the end-points of each Plan.

While the current account deficit in 2006-07 is 1.1%, by 2011-12 this more than doubles, to 2.4%, of a much larger GDP. Perhaps more startling are the projections for the trade balance. Given the strong projected growth of net exports of invisibles (service exports plus remittances) at an average of 28% per year in dollar terms, the trade deficit by the end of the Eleventh Plan is projected at a stunning 16% of GDP, or almost 220 billion dollars.

This then finally brings me to the interplay between supply-side and demand side policies. As Arvind Virmani, the Government's Chief Economic Advisor notes in a recent Finance Ministry Working Paper,* India's current problem is that there is too much, not too little, money wishing to enter India.

The challenge for macro and structural policies is to translate these flows into enhanced, efficient investment which will indeed ease the bottlenecks in the economy, but that will do so without raising inflation and inflationary expectations. This trick is particularly complex as 9% growth will require significant shifts in relative prices even as the aggregate expected price level remains in the target range. As Virmani correctly points out, this will require delicate co-ordination between trade policy, monetary and exchange rate policy, fiscal policy, capital account liberalisation and financial sector reform. To my mind there is a real issue of whether our existing institutional structures, with responsibility divided between the RBI, the Finance Ministry, the Planning Commission and the Commerce Ministry is well-suited to this task.

To conclude, a careful reading of the Plan reveals it to be a more radical document than one might imagine. Its basic message is that it is time to shift gear from exports as the main goal of policy to efficient domestic investment, disciplined and supported by liberal imports. If the real exchange rate has to appreciate (as it surely must) to achieve these medium-term goals "" well, let it.

*"Macro-economic Management of the Indian Economy: Capital Flows, Interest Rates and Inflation" Working Paper No. 2/2007-DEA. November 2007

The author is Director-General of the National Council of Applied Economic Research. The views expressed here are personal.