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December 12, 2005

Indian Economy|Development Strategy

The Growth Story



The Prime Minister, Dr. Manmohan Singh, has been talking lately about the possibility of India aiming at a growth rate of 8-10 per cent.  The Planning Commission has also signaled in the Mid-term Appraisal that the next Plan will be based on a growth rate of at least 8 percent.  How plausible is this goal?


Indian economic growth shows a clear break in growth performance around 1980.  But the growth story of the eighties and the nineties are different.


The eighties saw improved growth performance because the Indian economy was liberated from the food constraint by the green revolution and, to a more limited degree, from the foreign exchange constraint by the discovery of Bombay High. We also saw a significant improvement in management capacity in the public sector and the private sector.  A new generation of managers took over the reins of responsibility.  In the public sector, which had been run by engineering visionaries, the new managers were driven by the goals of efficiency in project implementation and global competitiveness. In the private sector the old pre-independence cadre of traders turned industrialists was replaced by a new generation of sons (and, more rarely daughters) trained in the ways of modern management.  All of this had a pay-off in terms of improved performance.


But the change was not sustainable.  The eighties did not see a substantial change in India’s position in the global economy.   Export promotion and attracting foreign investment were stated as goals of policy but the macro economy, including the exchange rate, were not oriented to this end.  At the end of the eighties the birds came home to roost and we faced perhaps the most severe crisis that the Indian economy has had to cope with in post-independence years.


The growth story of the nineties is based squarely on liberalisation initiated by Dr. Manmohan Singh as Finance Minister that allowed the boom in service exports and foreign investment inflows.  One of the most remarkable features of this period is the way in which Indian industry has adjusted to global competition with restructuring and technology upgradation, particularly in the past five years.  The one special feature of India amongst the emerging economies is this presence of private sector players with global ambitions.


Yojana Bhavan has been criticised in the past for making unrealistic projections.  But when it comes to growth rates it seems to have been quite cautious for most of the past twenty-five years.  The two plans of the eighties projected growth rates of 5.0 and 5.2 percent as against the actual realisation of 5.7 percent.  The post reform plans were more ambitious.  Thus the Eight Plan, formulated in 1992 projected a growth rate accelerating gently from 5,6 to 6.5 percent over fifteen years and the Ninth Plan put out in 1997 projected a growth rate accelerating from 6.5 to 8.1 percent over fifteen years.


Yojana Bhavan broke loose in the Tenth Plan.  The then Prime Minister, Shri Vajpayee, called for a doubling of per capita income in ten years, which would have required a growth rate of a little over 8 per cent, which was the target set in the Plan for the 2002-2007 period. A key assumption in the Tenth Plan was that the high growth rate of 8 per cent could be achieved with only a relatively modest investment rate of around 28 per cent, instead of 32 per cent or so suggested by the investment-growth relationship.


GDP growth has averaged 6.5 per cent in the first three years, which is below the Tenth Plan target but is higher than the business as usual path. Growth in 2005-06 is projected to accelerate but for the Plan period as a whole it is expected that actual performance will be around 7 per cent.  This is not bad given the fact that public savings have been well below target, that foreign capital inflow has led to reserve accumulation rather than higher capital spending, that the agriculture sector has stagnated and that infrastructure bottlenecks continue.  Clearly, if we can tackle these four factors there is good reason for supposing that a 8 growth rate is achievable.


Much of the low hanging fruit by way of improved capacity use has already been harvested and future growth will depend on sustained growth of private investment and also public investment in critical infrastructure.  The crucial issue is our capacity to raise public savings.  This has been the major failure so far.  The balance from current revenues of the Centre and the States has deteriorated sharply because of the Pay Commission recommendations and the rising debt burden. The consolidated public debt of the Centre and States taken together is about 80 per cent of GDP, which is among the highest in emerging market economies.


The inflow of capital from abroad does not translate into higher investment unless we run a current account deficit.  If foreign inflows consist largely of portfolio investment and a corresponding reserve accumulation then we will lose out as we will pay more to keep portfolio managers satisfied than what we will earn on our reserves.  The more effective uitilisation of foreign flows is one of the key challenges for higher growth.


Agricultural growth has decelerated sharply from 3.2 per cent between 1980-81 and 1995-96 to a trend average of 1.9 per cent subsequently..   The suicides of farmers suggests that this decleration affects not just the poor marginal farmers but is hitting at the productive core of the agricultural economy.  Agricultural growth cannot be revived without addressing basic issues about agricultural prices, investment in irrigation and land development and reforming agricutural support systems.  All of this depends on the state of public finances and. more important, the quality of administration, in the States and that is where the rub lies. A growth story is not plausible unless it includes measures to accelerate  agricultural growth in states like UP and Bihar and not just on the Punjab and Haryana.


So when the next Plan is released the real test of the high growth story that it will narrate will be the plausibility of its policy proposals on public savings, the utilisation of foreign inflows and agricultural growth.

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