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Economy: Tool-kit for growth!

Oct 4, 2004

The Indian economy witnessed robust growth in the first quarter of FY05, much helped by strong growth in the industrial and services segments and a decent growth in agriculture. However, when one considers the past, certain policies of the Indian government have also helped the growth of the Indian economy (now, let us not deny them their share of credit!). Going forward as well, there are some tools that the Indian government can use to pursue its aim of a high and sustainable growth of the Indian economy. But, what are those tools? In this article, we will try and understand the tools that the Indian government (or for that matter, any government in the world) can use to pursue its economic goals.

Objectives & instruments of economic policy
ObjectivesInstruments
Output / GDP growthFiscal policy
High and sustainable growth of GDPGovernment expenditure
 Tax policies
Price stability / Inflation control 
  
EmploymentMonetary policy
High level of employment with
low involuntary unemployment
Controlling the money supply through
adjusting interest rates

Let us understand the objectives in detail.

Output

The definitive objective of a government is to grow the economy's output or GDP at a strong and consistent rate. To do this implies that the government is able to provide goods and services that the population desires. In fact, what could be more important for an economy than to produce ample shelter, food, education and recreation for its populace?

Despite short-term fluctuations in business and economic cycles, economies, especially the developing ones like India, have shown steady long-term growth in GDP. For instance, the graph above indicates that while there has been volatility in the growth of Indian economy (on account of several factors like poor monsoons, governments' policies and poor investments), the trend is positive. This means that when we consider the 5-year rolling average of the Indian economy's growth, the momentum is on an upward move, indicating increasing strength and resilience of the economy.

However, to carry on with this upward move, the present government and those to come in the future need to make sure that their policies are both pro-market (aligning with the global economy and opening up to foreign markets) and pro-business (improving internal business climate). While the present government, like those in the past, has been loud on announcing policies for economic growth, the implementation remains a big issue.

Employment

Economic growth matters only when its benefits reach the poorest of the poor of the country. This is to say that economic growth without development has no meaning. And, for economic development of the society, high employment is the key. As per the US Central Intelligence Agency's World Factbook for 2003, India's unemployment rate stands at 9.5%, which means that one out of every ten people seeking employment is unemployed in the country. While this is lower than the unemployment rates for China (10.1%), Bangladesh (40%, including underemployment), Brazil (12.3%), it is much higher than that of other developing countries like Malaysia (3.6%) and Thailand (2.2%). This is probably the reason that while India has grown consistently on the GDP front, our per capita GDP still lags many a developing nations.

High employment and low unemployment is the ultimate fruit of a steady economic growth and progress. Of all the macroeconomic indicators, this factor most directly affects individuals. People want job security and benefits from the same for improving/maintaining their standard of living. In India's case, achieving the tenth plan's targeted 8% annual GDP growth rate is no option. Rather, to provide jobs to additional 10 m people every year, the economy 'has' to grow by this rate.

Stable prices

Stability in prices, or inflation control, is the third objective of any government's economic policy. Price stability is of utmost importance because, for a smooth functioning market system, it is necessary that prices accurately convey scarcities. This is to say that if demand increases in relation to supply, prices ought to go up. This is possible only when an economy maintains price stability. Both high and low inflation have costs attached to them. While high inflation results in increased cost of living and erosion of people's wealth, low inflation leads to reduction in the aggregate demand in the economy. This is because when people expect prices to decline or go down further in future, they postpone spending, thus affecting industries. This is the reason most central banks around the world work towards controlling inflation or maintaining a stable rate of inflation.

The Indian central bank, the RBI, stated in its annual report for 2003-04 that a rate of 5% is the stable inflation rate in the Indian economy. Off late, however, spiraling commodity and crude prices have led to increased levels of inflation in the economy. The present rate of 7.8% is far above the benchmark rate of 5% that the RBI had earlier stipulated.

To summarise the above discussion, the goals of a country's macroeconomic policy are -

  1. Growing and sustainable level of national output/GDP growth,

  2. High employment with low unemployment, and

  3. Stable or slowly rising price level.

In today's globalised world, the Indian government has no choice but to meet these abovementioned objectives through the right policy instruments (as mentioned in the table above). Apart from these, to attract the 'very much' sought after foreign capital, the government also has to work towards improving the institutional framework, reducing trade barriers and making the overall business environment more suitable for domestic and foreign investors in the country.

While the Indian economy is relatively more resilient to global uncertainties as compared to its Asian peers, we still have a long way to go. While a steady and strong economic performance is likely to bring in more opportunities for growth and development, investors need to believe that it is a long drawn process and would take some time to fulfillment. To that extent, we would reiterate our advice of a long-term approach towards investing in equity markets. Returns 'will' follow!


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