"The volatility in the agricultural economy is enormous and that is the worrisome part."

Mahesh Vyas began his professional career as a research assistant with Centre for Monitoring Indian Economy (CMIE) in 1980. He did his graduation in science and post graduation in Economics & Statistics. He then moved to International Economics to research the economics of East Asia and China between 1982 and 1985. Besides, he has worked on several sectoral studies and developed new systems at the CMIE. At present Mr. Vyas is CMIE’s Chief Economist and its Chief Executive. Besides, he is also a director on the board of Zurich Asset Management Company and a Member, Advisory group of the Comptroller & Auditor General of India.

In an interview with equitymaster.com he spoke about the growth prospects of the economy, elaborated the factors affecting rural demand and commented on the process of economic reforms.

EQM: The CMIE has toned down its growth prospects for the Indian economy for FY01. Please share with us the rationale for this move. When do you see growth regaining momentum? What is a sustainable level of growth for the Indian economy?

Mr. Vyas:We have scaled down our growth target for the current financial year from 7% to 5.8% and the main reasons are two. One is that the monsoon wasn’t as good as it should be. As a result of this agricultural production is expected to grow by only around 1.5% compared to our earlier forecast of may be 4.5%. And this has got an indirect impact upon the industrial sector. So both the agricultural and the industrial sectors will see a lower growth compared to what we have projected before the monsoons.

The second reason why we expect the growth to come down is that in the last twelve months the cumulative increase in the petroleum product prices has been 66%. So it’s not that one single increase has happened in September but the cumulative impact of such a steep rise in just one year will have another adverse impact on demand for industrial goods. So a combination of these two things would lead to a lower growth rate this year compared what we had anticipated. But I must add that 5.8% is not too bad.

As to your question of when will this turn around, I think it will take a while. It’s not going to happen in a hurry. Firstly, the damage has been done in the sense that the kharif crop was bad. Secondly, the rains were bad in the second phase. If we don’t have rains around now, it can have a bad impact on the rabi crop as well. So the rabi crop is, kind of, vulnerable. One cannot say that it will be bad, but one is sceptical of a sharp increase in rabi production.

And if we don’t see a good rabi crop which compensates for a loss in the kharif crop then there is no way in which the growth can rebound from lower planes we are talking about. The industrial sector depends upon this rural demand and if the latter doesn’t pick up I don’t see industrial sector picking up as well. Investments have been sluggish for the last three years. Unless demand picks up robustly, the likelihood of investment picking up is very bleak. So I don’t expect a turnaround to happen before summer 2001. And most likely the turnaround will happen only in June–July 2001.

EQM: Any sustainable rate of growth…

Mr. Vyas:See what is usually understood by a sustainable rate of growth is that growth rate which will not be accompanied by a very high inflation rate. We can certainly achieve about 6% with a moderate and acceptable inflation rate. But nowadays, its not a question of sustainable growth rates given some inflation target but the issue is more about how do you set the environment for a faster growth rate. And that I think is the more important issue. How do you accelerate the growth from around 6% to may be 8% or 10%. That is where we need to focus our attention. There is a normal growth we see nowadays of 6% and that doesn’t seem to hurt inflation too much.

I don’t like to call it sustainable growth rate. What is the meaning of sustainable growth? In a classic sense it mean’t you don’t pump in too much money to cause inflation to get the growth rate. But that’s not the way the economy is run nowadays. There is a strong eye on keeping fiscal deficit under control, not letting money supply go out of hand and inflation is largely controlled because globalisation helps keeps inflation low, you see an inflation rate of 7.5% but the manufactured goods are still growing at 2–3%.

So the concept of a sustainable growth rate is kind of archaic.

EQM: You spoke of a ‘modest and acceptable inflation rate’? What rate did you have in mind?

Mr. Vyas:In India 5–6% is modest and acceptable. Historically, we were comfortable with inflation rate of 7.5%. But that’s come down a bit now. We expect inflation to be lower than 7.5%. So I think that a modest and acceptable inflation rate will be closer to 5–5.5%.

EQM: You mean at this level the farm labourers or the lower strata do not get hit by rising procurement prices for agricultural commodities?

Mr. Vyas:No. You see the agricultural sector in so far as the inflation problem is concerned consists of two distinct groups. These are very distinct groups. One is the surplus crop producer. He benefits by a rise in agricultural product prices. Then there are those marginal farmers and farm labourers who actually suffer because agricultural products form a predominant share of their commodity basket. So when the prices of these commodities go up they get hurt extremely badly. If you see a 10% rise in primarily articles then it hurts a very large section of the farmers but it benefits a small wealthy group.

What I mean by 5–6% inflation acceptable rate is a rate at which one will not hear too much complaints about inflation from the vocal sections which are mostly the urban middle classes. One has never seen a rural rally against inflation. The rural classes quickly shift their consumption pattern. They move down below poverty line, they come back again. They are your classic economic agents.

Also keep in mind that in primary articles, prices are extremely volatile. So you will get some agricultural commodity for price X today and 2X or even ½X tomorrow. The variations are extremely volatile and that’s what hurts.

EQM: Looking at rural demand on a macro plane we’ve seen alternative years of boom and slowdown. What are the more fundamental factors that have afflicted the sector?

Mr. Vyas:The volatility in the agricultural economy is enormous and that is the worrisome part. A large part of the growth that we saw in the mid–nineties actually emanated from the agricultural sector which did extremely well. And when this sustained growth in agriculture faltered our growth rate also faltered.

Where are we lacking? We didn’t do much for the agricultural sector mind you. The liberalisation process or the capital markets do not touch the rural economy as much. What has helped agriculture is not liberalisation but government intervention. First, that large parts of the country particularly Punjab, Haryana, Western Uttar Pradesh as well as North Rajasthan has come under large irrigation projects. These have stabilised agriculture in this region which has created enough agricultural surplus. As a result our food grain production has increased steadily. This was all large public spending on irrigation, which saw this reach a level where today we don’t worry about food security.

In the late 1980s the government also intervened rather seriously to give better support prices to the farmers. And higher support prices combined with a good monsoon for about seven/eight years led to good agricultural production combined with good prices for agricultural commodities, which led to a high farm income which in turn gave a multiplier effect for industrial goods. So the moment this agricultural production growth faltered, one leg of the fantastic rural demand was taken away. All you had now was better farm prices. And because of the rains being not so good, agricultural production suffered every alternate year. And that’s what has led to a decline in rural demand. What do you do to correct this? You can’t go and cause rains. You got to do more irrigation. You got to bring about better farm practices, improve technologies, improve the productivity of the farm sector. Unfortunately, we have not paid attention to this. It’s not about giving sops to farmers. But we need to see how to get the growth process can work in the farm sector. How can you produce agricultural commodities not only for us, but for the world? We haven’t done much in that direction and there’s huge potential.

EQM: When you spoke of one leg of the rural demand falling off, isn’t it a fact that the higher procurement prices fuel the inflation cycle and hurt the marginal farmers?

Mr. Vyas:Yes they do.

EQM: Isn’t that then the key to sustainable rural demand? So by increasing procurement prices aren’t we actually knocking off…

Mr. Vyas:No. The demand for industrial goods comes from the surplus farmers. They are the ones who buy your motorcycles and televisions. Sustained growth due to higher procurement prices and good rains led to this big demand from them. For every affluent farmer there are hundreds of marginal farmers who get hit and they did get hit. But there were a very large number of affluent farmers and a growing number of them who did feed the growing demand for industrial goods. It worked both ways as poor farmers got hit by higher agricultural prices. But mind you for a long time they did not get hit because the Public Distribution System was kind to them. Andhra Pradesh had Rs 2/kg of rice scheme. So there was public intervention which did alleviate the poverty problem. There were the Jawahar Rojgar Yojanas, and those did take care of the poverty problem to some extent.

But now, the affluent farmers who had the benefit of higher prices and higher production don’t have the benefit of higher production. And that’s what is hitting rural demand.

For sustainable rural demand you can’t keep on giving higher procurement prices forever. You have to undertake better farm practices, land reforms, consolidation of land holdings (the average farm size in India is so small, you cannot undertake mechanisation of land). Efforts at soil conservation, soil enrichment, farm consolidation, better technology, better markets for farm commodities. Today a farmer has interface only with an intermediary and what the farmer gets is such a small fraction of what the consumer pays that the incentive for the farmer to improve farm practices is just not there. So there is a host of institutional reforms that can bring the farmer into the stream of purchases of white goods.

EQM: How in your view will the surge in international crude oil prices affect growth in the domestic economy? What will be the implications in terms of the forex markets, inflation and interest rates? Please share with us your forecast on these aspects.

Mr. Vyas:The most direct impact of the petroleum product price hike is on inflation. We have computed a 1.3% direct impact and there will be a cascading impact, which will happen gradually. So overall we expect a 2% rise in inflation and that is what we are seeing viz. a 7.5% inflation rate. And clearly the higher prices of petroleum products will have its impact on demand. So the demand for industrial goods will get doubly hit. Were it not for the rains, were it not for the 66% rise in petroleum prices, it would have been absorbed fairly easily but this has been too sharp for one year and combined with bad rains for the second consecutive year.

EQM: Central government finances have for the first time in years shown signs of improving. To what would you attribute this? What are the biggest threats to this improvement in fiscal state?

Mr. Vyas:I don’t think there is a major fiscal problem. I think the RBI is quite right in saying that there is a resilience in the economy. Non–plan expenditure is coming under reasonable control. The RBI’s worry that the Central government should borrow less is valid. The Central government’s requirement is equally valid. So that’s a good balancing act between the Ministry of Finance and the RBI. It’s very healthy and I think we are moving in the right direction.

EQM: What do you think is the main threat to this scenario?

Mr. Vyas:Growth. We require real GDP growth. Then our fiscal deficit will look small.

EQM: What are your projections for the Indian corporate sector in terms of growth and profitability? We had Infosys and Satyam but we also had Hindustan Lever and Ambuja. Your comments on overall corporate profitability…

Mr. Vyas:It basically has to do with the rural demand. Infosys caters to the export market, and they are running a different game altogether. The old economy basically services the needs of the domestic market. HLL has been around for decades, so obviously it would see slower growth when compared to a relatively new comer such as Infosys.India’s 5.8% growth looks great when compared to someone like Japan but those are much richer countries.

EQM: Investment activity in the economy continues to be sluggish. One reason could be demand. But could it also be due to the fact that the government is not doing enough to push activity in say power, roads etc?

Mr. Vyas:So far as power and roads is concerned, the government has may not have done enough. But what about the private sector? Why don’t they set up efficient textile mills, steel mills, cement mills? What’s stopping them? The basic infrastructure sectors suffer because the government has kind of withdrawn from investment activities in the hope that the private sector would take up the challenge. The private sector has not been able to take up the challenge fully. A part of the blame though lies on the government for not setting up the rules of the game and for not setting up the institutional framework, which is transparent, sustainable and complete. But a part of the blame goes to the private sector for not actually taking up the challenges of investment. We have the best natural resources, we have iron ore, bauxite, we have limestone, a huge consuming domestic market but our industrialists are not able to take up the challenge. They fear imports, forget about them looking at the world as their market. We need to see more entrepreneurship, more corporate leadership, which is global in nature.

EQM: How would you rate the performance of the government with regards to taking forward the process of reform?

Mr. Vyas:We certainly need to redefine this reform process. Reforms are not about opening up of sectors as much as it is actually correcting the old system. When people talk about the reforms sector they usually imply that the government should open up the insurance sector or any other sector which is fair but we need to do other things which are far more difficult to do such as reform the public sector enterprises, not just to privatise them. Some of them such as State Electricity Boards, the State Road Transport Corporation need to be reformed. The government machinery needs reform. You need to reset the structure under which the sectors perform. I think that is more important and that is not happening.

EQM: On a 10–year time frame where would you see India in the global economy?

Mr. Vyas:Certainly a very large consumer market. And in a 10–year time frame I expect to see a completely new class of entrepreneurs who will take up the new challenges to make India a global industrial power.

EQM: Who are the people that have influenced you the most?

Mr. Vyas:Gandhi. By reading him, not by meeting him. And Narottam Shah, the Founder Director of CMIE.