Can India grow at 8 to 9 per cent?
The Indian economy is currently passing through a phase of relatively slow growth. However, this should not cloud the fact that over the nine-year period beginning 2005-06, the average annual growth rate was 7.7 per cent. Against this background, the relevant question is whether India has the capability to grow at 8 to 9 per cent in a sustained way. In short, what is the potential rate of growth of India?
Normally, potential growth is measured using trends with some filters. In one sense, these are backward-looking measures, since they depend on historically observed data. In the case of measuring capacity utilisation in manufacturing, the maximum capacity is very often taken as the maximum output achieved in the recent period. Perhaps, in the case of determining the potential rate of growth of the economy also, one can take the maximum growth rate achieved in the recent past as the lowest estimate of the potential.
However, this assumption will be valid only if there is reason to believe that the maximum growth rate achieved in the recent past was not a one-off event and that the growth rate achieved was robust and replicable.
High-growth phase
India achieved a growth rate of 9.5 per cent in 2005-06, followed by 9.6 per cent and 9.3 per cent in the subsequent two years. After declining a bit in the wake of international financial crisis, the growth rate went back to 8.9 per cent in 2010-11. In many ways the growth rate achieved in the high phase period of 2005-06 to 2007-08 was robust.
The domestic savings rate during this period averaged 34.9 per cent of GDP. Similarly, the gross capital formation rate averaged 36.2 per cent. The current account deficit (CAD) remained low with an average of 1.2 per cent of GDP. Agricultural growth during this period averaged 5 per cent, and the annual manufacturing growth rate was 11 per cent.
The capital flows were large but as the CAD remained low, the accretion to reserves amounted to $144 billion. Inflation during the period averaged 5.2 per cent. The combined fiscal deficit of the Centre and States was 5.2 per cent of GDP, well below the stipulated 6 per cent. Thus on many dimensions the growth rate was robust. Unlike in the 1980s when the pick-up in growth was accompanied by deterioration in fiscal deficit and current account, the sharp increase in growth between 2005-06 and 2007-08 happened with the stability parameters at desired levels. Also, a booming external environment provided good support.
To assess whether the high growth phase can be replicated, we need to understand the factors that led to the slowdown since 2011-12. Complicating the analysis of this period is the revision of national income numbers with a new base. The two sets of numbers present a somewhat differing picture. According to the earlier series, the growth rate of the Indian economy fell below 5 per cent in 2012-13 and 2013-14. But the new series shows a decline below 5 per cent only in 2012-13. For 2013-14, the new series records a growth rate of 6.6 per cent, as against 4.7 per cent according to the earlier estimate. For 2014-15 and 2015-16, there is only one set of numbers, that is, according to the new series. For both the years the growth rate is above 7 per cent. These are good growth rates under any circumstance, let alone the current global situation. Anyway, we have come down from the growth rate of 9-plus per cent which we had seen earlier.
Three sets of reasons are attributed for the slowdown. First, the external environment had deteriorated sharply. The recovery from the crisis of 2008 was tepid. One country after another in the developed world came under pressure. Strangely, however, international commodity prices including crude oil prices remained high until a couple of years ago. All this had an adverse impact on developing countries, including India.
However, it would be wrong to attribute the slowdown in India primarily to external factors. The domestic factors are the key. Second, there were severe supply bottlenecks. Agricultural production fell sharply in 2009-10 because of a severe drought. This triggered an inflation which lasted for several years thereafter. Coal output fell. Iron ore output fell, partly because of court decisions.
The third set of reasons is basically non-economic which led collectively to a weakening of investment. A multitude of issues relating to scams and perceived delays in decision-making created an element of uncertainty in the minds of investors. New investments began to fall.
Productivity of capital
An analysis of the data of the period since 2012-13 reveals two trends. First, there has been a decline in investment rate. Second, the decline in growth rate is greater than the decline in investment rate indicating a rise in the incremental capital-output ratio (ICOR). In 2007-08, India’s investment rate was 38 per cent of GDP.It declined steadily to touch 34.8 per cent in 2012-13. This is according to earlier National Income estimates. However, according to the revised estimates, the investment rate began to fall only from 2013-14. The declining trend continues into 2015-16.
With an ICOR of 4, which was what it was in the high growth phase, even the lower investment rate should have given us a higher growth than what the economy has seen since 2011-12. The rise in ICOR can be attributed to the delay in completion of projects or the lack of complementary investments.
In some cases, it can also be due to non-availability of critical inputs. The delay in completion of projects can be due to internal reasons as well as policy constraints. It is here questions relating to land and environment enter. About two years ago, it was estimated that there were around 750 “stalled” projects with a total value of Rs.8.8 lakh crore. What then are the lessons that we can draw from this experience?
Even with the existing level of investment rate, it should be possible to grow at 7.5 per cent in the short run, provided ways are found to speedily complete projects. However, only a return to higher levels of saving and investment can take us back to 8-9 per cent growth seen earlier. Thus what is needed to achieve the “potential” is to raise the investment rate and improve the productivity of capital.
The emphasis on the level of investment and productivity of capital as key to achieve the “potential” raises another issue of whether the Indian economy is “supply constrained” or “demand constrained”. Most developing economies are generally “supply constrained”. India is no exception.
But there can be occasions such as the current phase in India where demand deficiency can be a critical factor. In fact, in the current situation, weakening of external demand has had an impact on manufacturing. There is no doubt that a buoyant external environment will play an important part in boosting domestic economy.
Gazing into the future
The rise in investment rate must be supported by a rise in the domestic saving rate. An increase in investment rate supported by a widening current account deficit is not sustainable and is fraught with serious consequences. Only a current account deficit in the region of 1 to 1.5 per cent is sustainable.
Incremental capital output ratio is a catch-all variable which is influenced by a host of factors. Obviously, it depends on technology. It also depends upon the skill of the labour force which in turn depends on the quality of the education system. Another catch-all expression “ease of doing business” is also relevant. Bureaucratic hurdles which impede speedy execution of projects need to be removed. Thus improving the productivity of capital needs action on several fronts.
Making a prediction about the future is always hazardous. Many things can go wrong. The Indian economy in the recent past has shown that it has the resilience to grow at 8 to 9 per cent. Therefore achieving the required investment rate to support such a high growth is very much in the realm of possibility.
However, we need to overcome the current phase of declining investment rate. Investment sentiment is influenced by non-economic factors as well. An environment of political and social cohesion is imperative. Equally, we can get the ICOR back to a lower level. Raising the productivity of capital will require policy reforms including administrative reforms as well as firm-level improvements. The “potential” to grow at 8 to 9 per cent at least for a decade exists. We have to make it happen.
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.