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Economic Survey: Sustainability is the key

Feb 25, 2010

The Finance Minister tabled the Economic Survey 2009-10 in the Parliament today. In summary, the survey has sent out positive vibes for India's economic future over the next 3 to 5 years. This is notwithstanding the immediate concerns of inflation and stimulus withdrawal. With respect to the former i.e., inflation, the survey has warned that food prices would continue to rise further over the next few months. In the same breath, it has also recommended a gradual rollback of stimulus measures after assessing the impact on each sector.Amidst all this, the survey seems extremely positive on India touching a double-digit growth rate over the next 4-5 years. As it states, "It is entirely possible for India to move into the rarefied domain of double digit growth and even attempt to don the mantle of the fastest growing economy in the world within the next four years." as for the current and next financial years (FY10 and FY11), the survey has projected GDP growth of 7.2% and 8.8% respectively.

Let us briefly discuss the key points of the survey.

Economic growth: Enthused by reforms and the strong fundamentals, the survey has predicted that India would bounce back to a high 9% growth in FY12. And this is not all! This surge in growth will lead the economy on a way to become the world's fastest growing economy in four years.

As for the current fiscal (FY10), the survey expects GDP to grow by 7.2%. This will largely be helped by 8.2% and 8.7% growth in the manufacturing and services sectors. The agriculture sector is however expected to decline by 0.2% during the year. The survey especially points to a renewed momentum in the manufacturing sector, which has largely been driven by pick-up in private sector investments. Going forward, the survey expects a pickup in domestic savings and investments to drive the Indian economy into a higher orbit. As per latest available numbers (FY09), India's savings rate stood at 32.5% of GDP. Gross domestic capital formation (investments) stood at 34.9% of GDP. These are amongst the highest rates in the world and speak volumes of the soundness of the Indian economy.

Inflation: The survey sees rising inflation as the biggest risk to the economy's growth in the short to medium term. It has noted that an economic recovery along with supply-side pressures are pushing up inflation in India. Further, it has warned that high food prices, which rose over 17% in January, could spill over into general inflation (which is already at around 7% currently).

Source: Economic Survey documents

Overall, the survey has criticized the government's policies in flagging expectations of high inflation in some commodities like wheat and rice (as prices rose despite there being ample stocks of these food items). It suggested - "Making available adequate and timely quantities of these items and at different locations to overcome supply side mismatches is the real challenge." Hope the government agencies are listening!

Stimulus withdrawal: The survey has recommended a 'gradual rollback' of stimulus measures after assessing the impact on each sector. This is while it has favoured providing further stimulus to the exports sector given that the recovery prospects in global markets (US and Europe) are still fragile. It indicates - "The downside risks for world and the Indian trade lie in the fact that though the fall has been arrested, both output and trade recoveries are still fragile given the fact that the recovery has been pumped up by the stimulus given by different countries, including India."

Amidst the debate on withdrawal of the stimulus, including speculation of a possible across-the-board roll back of cuts in excise duty and service tax, the survey has suggested further reduction in excise for export oriented industries.

Public finances

Until about the enactment of the FRBM Act, the Indian economy was quite used to witnessing a rather large structural fiscal deficit. In other words, the Government's expenses outpaced its revenues by a fair margin. However, the rapid and significant fiscal consolidation achieved in the post-FRBM period changed all that. In fact, in FY08, the fiscal deficit came down to as much as 2.6% of GDP and it was believed that India is finally entering a new era of structurally low fiscal deficits. But then came the commodity shocks and the subsequent financial crisis which kind of forced the government to drive away from the path of fiscal consolidation for a couple of years. Such steps were deemed necessary so as to prevent the domestic economy from going into a spiral of low growth.

Thus, the fiscal deficit ballooned once again to 5.9% of GDP in FY09 and is estimated to be in the region of 6.5% in the current financial year. As things stand today, the stimulus measures seem to have worked and we seemed to have avoided the worst. Thus, it is time we went back on the path of fiscal consolidation. As the economic survey points out, a lasting fiscal consolidation could accrue with reforms in the design and delivery of Plan schemes, outcome focus on expenditure and institutional reforms.

Banking

The survey has clearly underlined the positives and negatives of India being part of a mature global financial market. The presence of complex financial instruments (like such as asset-backed securities and derivatives) while on one hand spread risks over different asset classes, can on the other hand be hazardous if subject to faulty risk pricing. The survey explains that the recent experience from the global financial crisis has taught the lesson that the sophistication of financial markets may not make them immune to crisis. Particularly, if investors and regulators do not pay adequate attention to the risk rating and risk pricing.

With respect to the banking sector in particular, the survey has highlighted that the contribution of bank credit to corporate borrowing requirement has reduced over the last two fiscals. Primarily due to bank's voluntary risk averseness as also due to companies accessing other modes of finance. Growth in bank credit reduced from 22% in FY08 to 17% in FY09 and to 8% in 9mFY10. Further, the lesser risk exposed PSU banks took advantage of flight of capital to safety and managed to outdo their private sector and foreign peers in terms of growth. One of the major indicators suggesting that the Indian banking system has withstood the pressure of global financial turmoil is the improvement in the capital adequacy ratio from 13% in FY09 to 13.2% so far in FY10. This is notwithstanding the write-offs for incremental slippages in personal and agricultural loans.

Infrastructure

As far as the country's core infrastructure is concerned, the survey highlights signs of recovery evinced by the core industries and infrastructure sector after last year's brutal slowdown. Core industries like power, coal and other infrastructure like ports and roads were all seen reviving.

However, there are negatives too. Against a target for developing about 3,165 km length of national highways under the NHDP (National Highways Development Programme ) in FY10, the achievement till November 2009 has been only about 1,490 km. The pace of awarding new road projects also has been poor. Only 13% of the targeted road length for FY10 have been awarded in the first 8 months. Power too seems to tell a similar story. The actual capacity addition during 9mFY10 was only 44% of the full year target.

Easing of supply bottlenecks in certain sectors and demand recovery in some others has led to a gradual revival in infrastructure services. However, the survey also acknowledges the magnitude of the infrastructure deficit in the country. As also the desperate need for acceleration in infrastructure capacity addition. That said, the collapse of world markets disrupted a lot of the resources from entering the Indian infrastructure sector. However, evidence points towards a steady revival of flows of investible resources to infrastructure sectors during the current year. Going forward, channelising the population's huge savings base into India's critical infrastructure sector is going to be of utmost importance.

External Sector

The survey points out to an improved outlook for India's foreign trade in 2010. However, it has also warned that the downside risks for world and Indian trade lie in the fact that though the fall has been arrested, both output and trade recoveries are still fragile. This is given that the recovery has been pumped up by the stimulus given by different countries including India. And the effects of the same (stimulus) may dry up if natural recovery doesn't follow. Protectionism used by some countries (like the US) in response to high unemployment there can also be detrimental to world trade, including India's external trade.

Conclusion

With the full effects of the economic reforms of the 1990s working through the system, the Indian economy has moved to a higher growth path. The new challenge is to maintain growth at these levels, not to speak of raising it further to double-digit levels. With domestic experience of such high growth limited, global experience can be useful. Historically, there have been about a dozen medium/large countries that have averaged a GDP growth of 9% or more for a decade. Of these, less than half maintained an average growth of 9% or more for two decades. The challenges of high growth have become more complex because of increased globalisation of the world economy and the growing influence of global developments, economic as well as non-economic.

One key factor that can constrain India's superior economic growth in the future is the poor state of physical infrastructure. Despite efforts to accelerate the pace of infrastructure development, the demand for infrastructure services has grown even faster than the supply so that the constraints may have become more binding. Thus, there is a heightened urgency to augment and upgrade infrastructure, both physical as well as social and, in particular, power, roads and ports. This shall require mobilisation of unprecedented amounts of capital with macroeconomic stability, which can only happen if both the public and private sectors have the incentive and the motivation to perform at their best.

Overall, the key issues confronting India today are the sustainability of high growth with moderate inflation, and the inclusive nature of such high growth. The inclusive nature of the growth itself will be conditioned by the progress that is made in the areas of education, health and physical infrastructure. For this, the government needs to rise to the challenge of maintaining and managing high growth, bolster growth through fiscal prudence and high investment and improve the effectiveness of its intervention in critical areas such as education, health and support for the needy.

Only then will the growth path's trajectory will be maintained in the higher single digits or even double-digits!


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