What a change an year can bring? Change in beliefs, changes in mindset, and changes in performance. While the economic survey released last year was highly upbeat about India's GDP growing strongly and sustainably in the future, this year's survey seems a bit toned down as far as the enthusiasm is concerned. While the survey talks about the continuance of a strong GDP growth (expected to grow 8.7% YoY in FY08), the fact that it also highlights concerns to future growth is appreciable. The key concerns that the survey has talked about are –
poor infrastructure (both physical and social);
high inflation, largely on the back of globally high commodity prices (fuel, food and metals);
strong capital flows and the subsequent inability in managing the same (that has led to an appreciation in the Rupee); and
slowdown in consumer goods segment.
Let is briefly discuss the key points of the economic survey of 2007-08.
On economic growth…
The survey remains upbeat about India's economic performance, and expects the economy to cross the US$ 1 trillion GDP mark in the current fiscal. The survey projects the GDP at factor cost (at constant 1999-2000 prices) to grow by 8.7% during FY08. While the represents a deceleration from the superior growth levels of 9.4% and 9.6% achieved during FY06 and FY07 respectively, the survey takes comfort from the fact that some degree of cyclical fluctuation is to be expected considering that the Indian economy is rapidly modernizing and aligning with world economies. This survey, while reiterating the government's Eleventh Five Year Plan (FY08 to FY12) GDP growth target of 9%, mentions that maintaining the same (9% growth rates) and raising it to two digits will be a big challenge.
Specifically in respect of the deceleration of growth during the current fiscal, the survey has indicated that there has been an all-round pressure. Except sectors like electricity, community services and the composite category (that includes trade, hotels, transport & communications), deceleration has been witnessed across, with special mention of agriculture and manufacturing.
Slow growth in the agriculture sector is attributed to the slackening in the growth of rabi crops;
Manufacturing and construction, which grew at 12% in FY07, decelerated by about 2.5% in FY08 - the slower growth of consumer durables being the most important factor in the slowdown of manufacturing;
Cement and steel industries grew by 7.4% and 6.5% respectively during April-November 2007-08, down from 10.8% and 11.2% in the corresponding period of FY07.
Services sector has, however, maintained its strong run and is expected to grow by 10.7% during the current fiscal. Growth in the services sector has been led by strong performance from the transport and communication sub-segments, which have in fact averaged an annual growth 15.3% during the Tenth Five Year Plan period (FY02 to FY07). The construction segment also finds a special mention in the key drivers for services sector's growth during the said period. The survey mentions that the contribution of construction and telecom sectors increased to 10.8% and 11.4% respectively during the Tenth Five Year Plan from 7.5% and 6% respectively during the Ninth Five Year Plan. The growth of financial services, comprising banking, insurance and business services, after declining to 5.6% in FY04 has also bounced back to 13.9% FY07.
On savings and investment…
We believe that there is a tangible shift in the source of growth. It is the investment pattern rather than demand and consumption for consumer goods that has powered the last three years' spurt in GDP growth. Investment, in general being a forward-looking variable, reflects a high degree of business optimism and improved perception about the long-term macroeconomic stability of the economy. The gross domestic capital formation (which is the economic term for ‘investment'), which stood at less than 30% during the first half of this decade, spurted to almost 36% during FY07. This sharp increase in the investment rate has sustained the industrial performance and reinforces the outlook for future growth.
Importantly, the higher investment has also absorbed higher levels of domestic savings and has generated an appetite for absorption of capital inflows from abroad. As for the domestic savings, these have also shown a continuous improvement, rising from 26.4% of GDP in FY03 to 34.8% in FY07. This is mainly due to the households as well as the private corporates saving more than what they did in the past. But the real winner is the public sector that has turned from a net dis-saver to a net saver in the same period.
The economic survey has not really sounded alarm bells on inflation, indicating that the same, as measured by the Wholesale Price Index (WPI), is expected to be around the 4.4% levels in FY08 (from 5.4% in FY07). However, there is an indication of a flare up in the same in the last few weeks owing to rising prices of commodities like coal and crude oil. Overall, the survey has appreciated the fact that inflation management shall remain a key policy concern of the government. This is especially considering the fact that the change in the structure of the Indian economy and its more globalised nature has made management of inflation a complex task. The survey believes that with rising capital inflows, various monetary policy mechanisms will have a more decisive role to play going forward. At the same time, the RBI and the government have to tackle inflationary impulses from global commodity prices through the use of fiscal and trade policy instruments.
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.
Even the economic survey has taken note of this fact and has maintained that managing foreign capital inflows (alongwith inflation) is one of the key challenges that Indian policymakers will have to face in sustaining economic growth at high levels in the future. It is a given that high GDP growth attracts foreign capital looking for profitable investment opportunities. We believe that in a positive cycle, this inflow will indeed find profitable investment opportunities that others have missed and lead to even higher growth. However, if the growth opportunities do not materialise fast enough, there is pressure on the currency to appreciate, resulting in either an accumulation of reserves (followed by monetary expansion and inflation) or actual appreciation or both. In the last two years, particularly in FY08, the Indian economy has gone through such a phase. And there are reasons to believe that the surge in capital inflows, including foreign direct investment (FDI), will continue in the medium term, possibly intensifying the headache for the RBI.
Another factor that could constrain Indian economic growth in the future is the country's poor 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.
All in all, 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. Amen!