PARTHASARATHI SHOME

T

All these inter-connected factors need to support a comprehensive strategy for India to place herself on a 10 per cent growth path.

Savings, Investment and Finance

India is a high savings economy when viewed in international perspective. Reflecting India’s savings growth, investment has been high. The economy’s savings and investment rates are presently around 30 per cent of GDP, with decades of impressive growth in financial assets. This is remarkable when one considers India’s per capita income in a cross-country comparison.

But during this process, public savings did not perform too well while private savings – in particular household savings – experienced phenomenal growth. Total gross domestic savings in proportion to GDP rose continuously from about 10 per cent of GDP in 1950-55 to 28 per cent in 2003-04, the highest ever recorded. The public sector component of savings was always small, indicating that the public sector was barely meeting its own revenue expenditures. As administration and interest expenses increased, even current expenditures could not be met from revenue collections. Thus, dissaving emerged in the late 1990s and peaked in 2001-02. A turnaround appeared to have begun in 2003-04 as government made attempts to comply with its own Fiscal Responsibility and Budget Management (FRBM) Act. In fact, after two decades, from 2004-05, gross budgetary support for Plan expenditure once again was less than the fiscal deficit, implying that government stopped borrowing the entire amount of Plan expenditure.

There remains no doubt that households have been the overwhelming source of India’s savings. The growth occurred as bank branches penetrated all areas and improved both the quantum and the quality of savings, through rapid growth in household financial savings, presently comprising half of total household savings. We have come a long way since the development of early financial instruments to mobilise savings such as bank deposits, life insurance and provident funds. The new instruments are superannuation funds, mutual funds, stocks, derivatives and futures. The phenomenal Sensex growth of 50 per cent in 2005-06, to reach the 10,000 mark, clearly shows how new forms of savings have been embraced by savers not through government policy so much as through an impetus from the market supply of new instruments and commensurate response in demand. Of course, to counter the increasing risk and complexity of financial markets, control mechanisms function through the establishment and regulatory authority of SEBI.

It is well known that economic growth and investment are interlinked. Turning to the composition of investment, public investment has been mainly policy driven, resulting in a residual of loanable funds available for private investment. However, public investment is also complementary to private instrument. Interestingly, the cutback in public investment during the 1991-94 fiscal tightening seems to have affected private corporate investment adversely. This reflects a widely prevalent view that the relative inadequacy in the public provision of economic infrastructure has been at least partially responsible for the inability of private investment to achieve its full potential in terms of output and economic growth.

In the area of investment, the policy that had led to early success in directing credit to priority sectors has been eased through the deregulation of lending rates. In turn, this has led to improvements in resource allocation, though the impact on rural credit available to the marginal farmer clearly calls for improvement. With respect to industry, the government continues to attempt to direct private investment through various incentives and exemption schemes from both direct and indirect taxes. Such schemes may be for encouraging research and development in particular sectors, or recognising and accommodating private sector participation in sectors that represent the public good, but the public sector, for various reasons, cannot supply adequate public resources, or for developing infrastructure, or to encourage international competitiveness. But incentives are also given for the development of major regions, or for employment generation, or to provide estate facilities for businesses to operate. While each of these must have been introduced in the context of public interest, the net result is uncertain, and leads to acrimonious contention among regions, or to competitive industry representations for bigger benefits. The challenge remains, therefore, to provide a comparatively level playing field to industry and to ensure neutrality in resource allocation.

Returning to the issue of achieving the 10 per cent growth target, enhancement of efficient investment is called for. Conflicting objectives – other than efficiency – though they may have to be accommodated in India’s heterogeneous, sub-continental geographical area – would necessarily result in accommodations. This would, in turn, translate to a longer period for the goal to be achieved.

Higher investment that would be needed would have to be financed both from domestic savings as well as from foreign investment. Such higher savings are a function of positive real interest rates, a low inflation rate within an anti-inflation policy framework, and a steady rise in per capita income. And higher foreign investment would occur only if the underlying macroeconomic framework is stable and predictable in the medium term.

To sum up the discussion on savings and investment, if already we are touching an

Economic and Political Weekly March 18, 2006 8 per cent growth rate, then we need to garner higher savings and higher investment to reach a 10 per cent growth target. In addition, for a 10 per cent growth rate, clearly more units of output growth would be essential from every unit of investment, however much extra savings and investment are generated in the economy.

If one examines India’s growth swings, what becomes immediately obvious is that a year of high economic growth is preceded by a year of low agricultural growth that accounts for a low base from which springs the next year’s high growth. In the 2000s, agriculture has managed only 1.5-2.0 per cent growth, compared to 7-9 per cent for manufacturing and services. As the majority of arable land remains unirrigated, agricultural sector growth is determined by the vagaries of the monsoon. Volatility in agricultural growth translates also to unwarranted variations in overall growth. Clearly, therefore, in order for stability to be achieved in economic growth, and to attain a 10 per cent growth path, agricultural growth has to be stabilised. For this stability, the only solution is irrigation since more than half of India’s agriculture is still only rainfed. Just as our high savings rate is quite remarkable, it has to be admitted that it is equally astounding that we have not been able to achieve agricultural stability so far. There seems to have been a long pause after C Subramaniam’s green revolution. It is time to take it up forcefully.

Let me make the point with a few indicators of the composition of GDP over the last decade in order to infer on the relative merits of an appropriate agricultural policy (see the table).

Over the last decade, the share of agriculture, forestry and fishing dropped remarkably from 31 per cent in 1993-94 to 22 per cent in 2003-04. Since industry on the whole has remained the same at around 19 per cent (with manufacturing gaining only one percentage point, from 16 per cent to 17 per cent), it becomes obvious that the gains have been made overwhelmingly in the services sector. The gains comprise: communication (3 per cent points), trade (2 ½ per cent points), banking and insurance (1 ½ per cent points), social and personal services (1 per cent point), nonrail transport (1/2 per cent point), and hotels and restaurants (1/3percentpoint).

Interestingly, public administration and defence remained the same contrary to popular belief on the matter.

The conclusion remains that agriculture has suffered a stark decline from which a large part of India’s population derives sustenance.1 Note that the prevailing composition of GDP implies that, even if agricultural growth is raised to 4 per cent, in order to attain 10 per cent overall growth, industry would need to grow at 10.5 per cent and services at 13.5 per cent (if public administration growth is maintained at a minimum, say 0.1 per cent).2

Would raising agricultural rate of growth to 4 per cent be a mammoth task? Recently, economist Surjit Bhalla has calculated that, over the last century, only during the following five-year periods ending in 1970, 1971, 1977, 1984, 1992 and 1996, has a 4 per cent agricultural growth been achieved. For periods ending 1970 and 1977, the rainfall index was in the top 5 per cent of rainfall in 135 years; for the other four referred years, the index was in the top 18 per cent. He further shows that rainfall is positively correlated to agricultural GDP while, as may be expected, it is negatively correlated with a one year lagged index.3

It appears, therefore, that 4 per cent agricultural growth has been achieved only in a few years when rainfall was much higher than average. Despite being a mammoth task, it could be achieved with finely targeted policies. The government has increased agricultural credit multifold but this could comprise only a small though significant element in any strategy for agricultural revival. Investment in irrigation, perhaps in a public-private partnership, is imperative in lifting India out of the limiting effects of her rain driven agricultural fate. The need for an irrigation strategy looms large on the horizon of essentials. Irrigation remains the crux of successful agricultural growth.

I would like to conclude on this point with one caution, however. We cannot focus on agriculture alone since the ramifications of a rise to a 4 per cent growth in agriculture alone would have to be analysed carefully in terms of excess supply of farm products, in particular, crops. We would need to assess absorptive capacity and maintenance of market demand. Thus, what is needed is a comprehensive approach to the entire sector, including forestry and fishing, and other components. These subsectors could grow perhaps at higher than 4 per cent – and feed into food processing – and agriculture at slightly lower than 4 per cent, so that the composite sector would grow at 4 per cent. And, as I indicated, that would need much expanded irrigation and other infrastructure.

The FRBM Act has disciplined the union government to adhere to a tight fiscal policy, reining in its fiscal and revenue deficits. By reducing the fiscal deficit by 0.3 per cent of GDP every year, and the revenue deficit by 0.5 per cent of GDP every year, it proposes to reduce the fiscal deficit to 3 per cent of GDP and the revenue deficit to 0 per cent of GDP by 2008-09.

So far it has done so. The finance minister had indicated during his 2005-06 budget presentation, that he may have to put a temporary pause on the FRBM goals. Yet, given high business confidence and excellent fiscal performance, he may yet be able to successfully meet his overall FRBM agenda. Most states have also

Exports, Imports and Effects of Globalisation

In the April-December period of 2005, exports grew 18 per cent in dollar terms while imports grew 27 per cent (nonpetroleum grew 20 per cent). India’s foreign exchange reserves were $ 133 billion in January 2006, an enviable difference from the $ 1 billion (three weeks of imports) she experienced in April 1991 before she entered her new era of economic liberalisation and fiscal consolidation. Nevertheless she is far from being able to compete with China on this count whose known or declared reserves are counted in multiplesof ours. Further, India’s net international reserves seem to have plateaued for a short while.

While India’s export growth is not unimpressive, it is the intrinsic feeling that we could just about cross the threshold to get to a higher position that is driving us further and further on and we shall achieve it! Indeed, in a sense, we may be somewhat better off in terms of long-term resilience against global exogenous shocks. Let me elaborate.

There is a recognition in the international economic community regarding the possible adverse ramifications on the global economy of excessive US demand coupled with the heavy export orientation of China. In this connection, the following hypothesis has been put forward in an analysis by Stephen Roach of Morgan Stanley:

What would the ramifications be of US economic behaviour on economies such as China and India? It is likely that Indian economic growth could turn out to be more sustainable than that of China. (i) While Chinese industrial production has been growing at 16-17 per cent per annum, China is more export dependent at 35 per

Economic and Political Weekly March 18, 2006 cent of GDP. Thus, any belt tightening in the US will hurt China significantly. (ii) In turn, East Asian economies that are dependent on Chinese demand, such as Japan, Korea and Taiwan, would be adversely affected. (iii) Given that personal consumption as a percentage of GDP in China is less than 45 per cent – lower than that of India – it is safe to assume that India’s internal demand would act as a better buffer than that of China in the likely event of a US downturn.

To conclude on the Morgan Stanley study, therefore: (i) The globalising world is increasingly dependent on exports;

(ii) Much of this is represented by excessive demand from the US; (iii) The US demand is bound to be scaled back; (iv) The trading world has to be prepared for what may turn out to be a downturn in the US economy and, consequently, in world demand, in 2006.

Of course, a counterpoint may be made regarding the continuing likelihood of the US current account deficit being met by world demand for US debt. This has been evidenced even in the period subsequent to the $/euro exchange rate adjustment. Thus one certainly cannot rule out that high deficit financing in the US could continue to occur for some more time. But from India’s point of view, what is important to keep in mind is that, in the context of international demand volatility, we are better off to be poised in a fine balance between domestic demand-generated and export-led economic growth, as opposed to east Asian economies that are more export dependent than India. This should facilitate India’s quest to reach the 10 per cent economic growth threshold in a more sustainable manner.

Last but not least, as is often discussed, a wide lacuna in India’s economic growth future is the state of economic infrastructure and overall institutional framework. While China is adept in providing the best ports, airports, highways and special economic zones, India has been characteristically slow in organising such facilities. Electricity and power face difficulties with a rate of growth of around 5 per cent only in April-November 2006. That manufacturing has grown at over 9 per cent in this time period, immediately reflects the scarcity of electricity that must affect economic growth adversely. A Special Purpose Vehicle was set up in 2005 to enable private public partnership (PPP) in infrastructure financing but it is well known that the gap is not merely in the provision of financial resources. Financial reform since 1994 has provided considerable financial stability in the form of decreased non-performing assets. However, achieving economic efficiency in resource allocation through loanable funds is a more difficult objective to achieve.

Industrial deregulation has been by and large completed other than reservations for small-scale industry and associated tax benefits. Foreign direct investment is now allowed in almost every sector. There are no restrictions except in insurance (capped at 26 per cent, without consensus yet whether to raise it to 49 per cent); banking (Reserve Bank of India’s roadmap for the next four years allows foreign banks to own 74 per cent of an Indian bank, though it is not clear when they would be allowed to enter); and retail trade (an area that is hotly debated).

In the social sector, primary health and primary education are recognised by government as the bread and butter of economic development. But resources remain insufficient for improving systems and for universal provision. Yet the mid-day meal programme for schools across the country is a valiant effort to attract children to school and to provide them adequate nutrition. The government has also been attempting decentralisation as a means of efficient provision of these services.

Labour reform also needs to be addressed. Our exit policy for investors is not yet internationally comparable. But at least there is increasing recognition that reform is necessary even in the Left ruled state of West Bengal where the information technology industry has been declared to be out of the stringent labour parameters.

Finally, institutions such as property rights, law and order, and the judicial process are all matters that must be addressed comprehensively in order for India to realistically achieve a 10 per cent economic growth. The recent introduction of the Right to Information Act arrived a bit as an unexpected guest to the bureaucrat’s door on October 12, 2005, but it has certainly opened the doors for improved transparency in governmental decision making, accountability and honesty. They should all combine to make a 10 per cent growth rate feasible if taken up concurrently and meaningfully.

Economic and Political Weekly March 18, 2006

Concluding Remarks

The outlook for India is remarkably good. Bank, corporate and personal balance sheets are strong, perhaps never stronger. Banks’ NPAs are tolerable. Household savings are at 25 per cent of GDP, yet consumers are credit rich. Corporations are experiencing high profits. The stock market is at a record high. So domestic demand is expected to remain high. Commodity markets are at their strongest. Lead manufacturing sectors such as software, textiles and steel have yielded dividends, and others are soon to follow to provide robust growth to exports. The growth rate of capital goods imports has gone up from 5 to 30 per cent over the last year, revealing a rush in real investment.

The government fully recognises the need for infrastructure, in particular, electricity and power. Private commercial investment in infrastructure is occurring and PPP is being encouraged. In telecommunications, cell phones have captured and saturated urban demand and are about to penetrate the rural potential. A difficult step has just been taken in privatisation plans for two major airports, though other airports remain. Earlier crisis-fed policies reflected in price and production controls, rules and regulations, and an attitude of looking over the shoulder to manage scarce resources, have been largely overcome. The air is one of optimism but we should not be making the same mistake as the India Shining policies entailed, for there may be long-term ramifications of neglecting the poor and vulnerable, in particular the rural sector. With that as a flag that must be raised as the foremost priority for attention, India is well poised to forge ahead perspicaciously on to a 10 per cent economic growth path.

EPW

Email: p.shome@nic.in

agriculture comprises just over one-fifth of GDP,

it gives pause for thought regarding India’s distri

result in low (agricultural) GDP in year 1 but,

because of this lower base, should result in high

(agricultural) growth in year 2.