SPECIAL ARTICLEEconomic & Political Weekly EPW may 10, 200861Based on the keynote address at the conference “Growth and Macroeconomic Issues and Challenges in India” organised by the Institute of Economic Growth, New Delhi, on February 14, 2008. Assistance of Michael Patra, Janak Raj, Dhritidyuti Bose, Binod B Bhoi and Muneesh Kapur in preparing the speech is gratefully acknowledged.Rakesh Mohan (rakeshmohan@rbi.org.in) is with the Reserve Bank of India.Growth Record of the Indian Economy, 1950-2008: A Story of Sustained Savings and InvestmentRakesh MohanIndia now grapples with the issues and challenges for sustain-ing the elevated growth momentum that it has achieved. This has assumed added contemporary significance in the wake of expected moderation in global growth due to a projected slow-down in the US and some other advanced economies. Whereas emerging markets, including India, have so far not been greatly affected by the financial turbulence in advanced economies, the increasing global uncertainties need to be watched and guarded against appropriately. Although our growth process continues to be dominated by domestic factors, we need to recognise some changing global patterns, which could have implications for the macroeconomic prospects of the Indian economy. I first review the overall macroeconomic performance in India since independ-ence, then draw the likely prospects for the coming five years and finally conclude with some issues that need to be addressed for sustaining the growth of the Indian economy.1 A Review of the Indian Growth ProcessThis section first discusses the acceleration in growth and then examines the trend in savings and investment.Growth Acceleration over the DecadesIt is widely believed that the Indian economy witnessed near stagnation in realGDP growth till the late 1970s. A closer review of the performance of the Indian economy, however, suggests a continuing increase in realGDP growth over each decade since independence, interspersed with an interregnum during the 1970s (Table 1, p 62). Interestingly, growth of manufacturing pro-duction, in terms of decadal averages, was roughly constant at around 5.6-5.9 per cent in the first five decades after independ-ence, except for the 1970s. There are two other features of our growth history that are notable. First, agricultural growth has been subject to large variation over the decades. The 1970s inter-regnum is particularly marked by the severe deceleration in agri-cultural growth, followed by a marked recovery in the 1980s, and a slowdown thereafter. Second, until the 1990s, little note had been taken of growth in the services sector. A glance at the growth record suggests that it is the continuing and consistent acceleration in growth in services over the decades, that had ear-lier been ignored, that really accounts for the continuous accel-eration in overallGDP growth, once again, except for the 1970s interregnum. There is nothing particularly special about service sector growth over the last decade.The slowdown of growth witnessed during the 1970s was reversed during the 1980s; the pick-up benefited from the ini-tiation of some reform measures aimed at increasing domestic This paper first reviews the overall macroeconomic performance in India since independence, and then assesses the likely prospects for growth in the medium term. It argues that India’s growth has been largely enabled by the availability of domestic savings, which have increased steadily over the decades. Further, the efficiency of resource use has been high with a long-term incremental capital-output ratio of around 4, which is comparable to the best in the world. While private investment and corporate growth have beenmajor factors in the recent growth upsurge, it is important to note that this period has also been marked by a relative decline in public investment. A revival of public investment, accompanied by higher public savings, would be necessary to improve and expand public services.

SPECIAL ARTICLEmay 10, 2008 EPW Economic & Political Weekly62competitiveness. Since the early 1990s, growth impulses appeared to have gathered further momentum in the aftermath of comprehensive reforms encompassing the various sectors of the economy. There was some loss of the growth momentum in the latter half of the 1990s, which coincided with the onset of the east Asian financial crisis, setbacks to the fiscal correction proc-ess, quality of fiscal adjustment, slowdown in agriculture growth affected by lower than normal monsoon years, and some slacken-ing in the pace of structural reforms. The slowdown could also be attributed to the excessive enthusiasm and optimism in regard to investment plans in domestic industry following deregulation, which was followed by significant problems experienced in viability and competitiveness. Monetary tightening in the face of inflationary pressures is also believed by some to have contrib-uted to the slowdown over this period. Since 2003-04, there has been a distinct strengthening of the growth momentum. Restructuring measures by domestic industry, overall reduction in domestic interest rates, both nominal and real, improved corporate profitability, a benign investment climate amidst strong global demand and commitment rules-based fiscal policy have led to real GDP growth averaging close to 9 per cent per annum over the four-year period ended 2006-07; growth in the last two years has averaged 9.5 per cent per annum. Consistent Growth in Savings and InvestmentIn analysing the growth record of the Indian economy, various scholarly attempts [DeLong 2003, Panagariya 2004, Rodrik and Subramanian 2004, and Virmani 2004] have been made to identify the turning point from the “traditional” low growth to the mod-ern high growth since the 1980s. The simple ordering of the data presented here provides a somewhat different picture of contin-ued slow acceleration in growth except for the 1970s decade. What can explain this continued acceleration? The secular uptrend in domestic growth is clearly associated with the con-sistent trends of increasing domestic savings and investment over the decades. Gross domestic savings have increased continuously from an average of 9.6 per cent of GDP during the 1950s to almost 35 per cent ofGDP at present; over the same period, the domestic invest-ment rate has also increased continuously from 10.8 per cent in the 1950s to close to 36 per cent by 2006-07. A very significant feature of these trends in savings and investment rates is that Indian economic growth has been financed predominantly by domestic savings. The recourse to foreign savings – equivalently, current account deficit – has been rather modest in the Indian growth process. We may also note that the two decades, 1960s and 1980s, when the current account deficit increased margin-ally towards 2 per cent of GDP, were followed by significant balance of payments and economic crisis. The long-term upward trends in savings and investment have, however, been interspersed with phases of stagnation. In partic-ular, during the 1980s, the inability of government revenues to keep pace with the growing expenditure resulted in widening of the overall resource gap. Accordingly, the public sector saving-investment gap, which averaged (-) 3.7 per cent of GDP during the period 1950-51 to 1979-80, widened sharply during the 1980s culminating in a high of (-) 8.2 per cent ofGDP in 1990-91. The resultant higher borrowing requirements of the public sector led the government to tap financial surpluses of the household sector through enhanced statutory pre-emptions from financial inter-mediaries at below market clearing interest rates. As fiscal defi-cits widened beginning in the 1970s, periodic increases in the statutory liquidity ratio (SLR) were resorted to finance the rising fiscal gap, indicative of the financial repression regime in place. The SLR was raised from 20 per cent in the early 1950s to 25 per cent by 1964, and it remained at that level for the rest of the decade. Beginning in the 1970s, the SLR came to be used more actively and it was raised in phases reaching 34 per cent by the late 1970s. The process continued during the 1980s as fiscal deficits expanded further, and the SLRreached a high of 38.5 per cent of net demand and time liabilities (NDTL) of the banking system in September 1990. The growing fiscal imbalances of the 1980s spilled over to the external sector and were also reflected in inflationary pressures. Along with a repressive and weakening financial system, this rendered the growth process of the 1980s increasingly unsustain-able. The external imbalances were reflected in a large and unsustainable current account deficit, which reached 3.2 per cent of GDP in 1990-91. As the financing of such a large current account deficit through normal sources of finance became increas-ingly difficult, it resulted in an unprecedented exter-nal payments crisis in 1991 with the foreign currency assets dwindling to less than $ 1 billion. The financ-ing problem was aggravated by the fact that the defi-cit was largely financed by debt flows up to the late 1980s, reflecting the policies of the time, which pre-ferred debt flows to equity flows. Indeed, equity flows were almost negligible till the early 1990s. Moreover, a significant part of the debt flows during the late 1980s was of a short-term nature in the form of bankers’ acceptances; such flows could not be Table 1: Macroeconomic Indicators at a Glance(in %) 1950s* 1960s 1970s 1980s 1990-91 1991/92 to 1997/98 to 2003/04 2007-08 (AE) 1996-97 2002/03 2006/07 1 2 3 4 5 6 7 8 9 101 Real GDP growth 3.6 4.0 2.9 5.6 5.3 5.7 5.2 8.7 8.7 Agriculture and allied 2.7 2.5 1.3 4.4 4.0 3.7 0.9 4.9 2.6 Industry 5.8 6.2 4.4 6.4 5.7 7.0 4.1 8.3 8.6 Manufacturing 5.8 5.9 4.3 5.8 4.8 7.5 3.9 9.1 9.4 Services 4.2 5.2 4.0 6.3 5.9 6.4 7.8 10.2 10.62 RealGDCF/GDP 12.5 16.9 19.4 20.2 24.4 22.5 24.1 31.4 NA3 ICOR 3.5 4.3 6.6 3.6 4.6 4.0 4.6 3.6 NA4 NominalGDCF/GDP 10.8 14.3 17.3 20.8 26.0 23.9 24.5 33.0 NA5 GDS/GDP 9.6 12.3 17.2 19.0 22.8 22.7 24.1 32.7 NA6 Saving-investment gap/GDP (5-4) -1.2 -2.0 -0.1 -1.8 -3.2 -1.2 -0.4 -0.3 NA7 M3 growth 5.9 9.6 17.3 17.2 15.1 17.5 15.9 16.8@ 23.8 #8 SCB’s non-food credit growth --17.5 17.8 12.4 16.2 15.3 26.5@ 23.1#9 Growth in investments in governmentsecurities 12.4^ 5.6 20.8 19.4 18.2 21.5 22.0 10.2@ 26.7#10 WPI inflation (average) 1.2 6.4 9.0 8.0 10.3 9.6 4.6 5.5 4.1 ##AE: Advance estimates.@: Adjusted for the mergers and conversions in the banking system. Variation for 2005-06 is taken over April 1, 2005.*: Average for the growth rates of the various indicators for 1950s is the average of nine years, i e, from 1951-52 to 1959-60.^ : Average of 1952-53 to 1959-60. #: As on January 18, 2008(year-on-year). ## : As on January 26, 2008 (year-on-year).

Revenue deficit Gross fiscal deficit Monetised deficit Gross primary deficit ReversalConsolidationFRBM

SPECIAL ARTICLEmay 10, 2008 EPW Economic & Political Weekly641995-96 to around 23 per cent in 2001-02. Concomitantly, the growth process suffered a setback with the realGDP growth decelerating to 3.8 per cent by 2002-03. Public Sector SavingsIn view of the deterioration in fiscal deficits over the period 1997-98 to 2002-03 and rising public debt, and its adverse impact on public investment and growth, a renewed emphasis was laid on improving the health of public finances on a durable basis. In order to achieve this objective, fiscal consolidation has been guided by the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 at the centre and similar fiscal responsibility legislations at the state-levels. Since 2002-03, significant gains have been witnessed in the fiscal consolidation process, both at the centre and the states, partly as a result of the implementation of the rule-based fiscal policies at the centre and the states. A major factor contributing to the durability of the fiscal con-solidation process under way in India in recent years has been the buoyancy in the revenues accompanied by some reprioritisation of expenditure with a focus on outcomes, unlike the expenditure compression strategy in most other countries as also the experi-ence in India in the 1990s. The revenue augmenting strategy encompassed moderating the tax rates and broadening the tax base through expansion in the scope of taxes, specifically service tax, removal of exemptions, some improvement in tax adminis-tration with a focus on arrears recoveries. Reflecting these meas-ures, the tax-GDP ratio of the centre has steadily risen from 8.2 per cent in 2001-02 to 11.3 per cent in 2006-07(RE) and 11.8 per cent in 2007-08(BE). The entire increase in tax revenues was mainly on account of the buoyancy in direct taxes. On the expenditure front, while the total expenditure of the centre declined from its recent peak of 17.0 per cent ofGDP in 2003-04 to 14.1 per cent in 2006-07 (RE), the capital outlay rose from 1.2 per cent to 1.6 per cent of GDP. The movement in key deficit indicators reflects the progress made so far in fiscal con-solidation. The fiscal deficit of the centre and the states taken together has declined from 9.9 per cent of GDP in 2001-02 to 6.4 per cent in 2006-07 led by a reduction in the revenue deficit from 7.0 per cent of GDP to 2.1 per cent. Apart from the quantitative improvement, a salient feature of the fiscal consolidation under way has been some qualitative progress made as reflected in the reduction in the proportion of revenue deficit to gross fiscal deficit. As a result, the dissavings of government administration declined from (-)6.0 per cent of GDP in 2001-02 to (-)1.3 per cent in 2006-07. The savings of the departmental enterprises at 0.6 per cent in 2006-07 were unchanged from those in 2001-02. The major component of public sector savings, i e, savings of non-departmental undertakings, has, interestingly, exhibited a steady improvement since the 1970s and this process has contin-ued during the reforms period (Table 4). Thus public sector enter-prises have exhibited continued and steady improvement in their commercial functioning since the early 1990s. Consequently, since 2003-04 onwards, total public savings have turned positive again. The savings rate of the overall public sector improved from (-) 2.0 per cent of GDP in 2001-02 to 3.2 per cent of GDP in 2006-07. Notwithstanding the striking improvement over the past few years, it may be noted that the public sector savings rate at 3.2 per cent during 2006-07 was still less than the peak of over 5 per cent touched in 1976-77. Nonetheless, the turnaround of 5.2 percent-age points ofGDP in public sector savings – from a negative 2.0 per cent ofGDP in 2001-02 to a positive 3.2 per cent of GDP in 2006-07 – has been a key factor that has enhanced domestic sav-ings from 23.5 per cent to 34.8 per cent over the same period. The public sector investment rate increased from 6.9 per cent ofGDP in 2001-02 to 7.8 per cent in 2006-07, but this level is still signifi-cantly lower than the public sector investment rates of the 1970s, 1980s and early 1990s. Despite this increase, this sector’s saving-investment gap has narrowed down from 8.9 per cent of GDP to 4.5 per cent during 2001-07, reflecting a turnaround in the public sector savings (which rose from (-) 2.0 per cent to 3.2 per cent) enabled by the implementation of the fiscal rules. Performance of the Private Corporate SectorThe reduced requirement by the centre for meeting budgetary mismatches, and for overall public sector financing has improved the availability of resources for the private sector considerably. Furthermore, the corporate sector has responded to increased global competition by improving its productivity and efficiency through increased application of technology. The economic Table 4: Public Sector Saving and Investment Rates (% of GDP) 1970s 1980s 1990-91 1991-92 to 1997-98 to 2003-04 to 1996-97 2002-03 2006-07 1 2 3 4 5 6 7Savings Government administration 2.5 0.8 -1.8 -1.6 -4.8 -2.4Departmental enterprises 0.6 0.4 0.6 0.8 0.7 0.5Non-departmental enterprises 1.2 2.5 2.9 3.0 3.4 4.1Total public sector savings rate 4.2 3.7 1.8 2.2 -0.7 2.3Public sector investment rate 8.6 10.6 10.0 8.7 6.9 7.1S-I Gap -4.4 -6.9 -8.2 -6.5 -7.5 -4.9Table 5: Corporate Financial PerformanceItem 1990-91 1991-92 to 1997-98 to 2003-04 to 2006-07 2007-08 1996-97 2002-03 2006-07 (Apr-Sept)(Apr-Sept) 1 2 3 4 5 6 7Growth rates (%) Sales 15.816.9 7.0 20.7 27.417.4Expenditure 15.116.67.419.725.616.9Depreciation provision 10.1 16.6 12.9 10.2 16.1 15.1Gross profits 27.8 18.2 3.6 30.9 39.8 28.1Interest payments 16.2 18.7 3.8 -0.6 20.8 10.1Profits after tax (PAT) 53.3 21.1 7.8 47.3 41.6 31.1Select ratios (%) Gross profits to sales 11.2 12.4 10.6 12.7 15.6 16.9PAT to sales 4.0 5.5 3.6 8.0 10.6 11.7Interest coverage ratio (Times) 1.9 2.1 1.8 5.2 7.1 8.4Interest to sales 5.8 6.0 6.0 2.6 2.2 2.0Interest to gross profits 51.6 48.5 56.6 21.0 14.1 11.9Interest to total expenditure 5.8 6.0 6.0 2.8 2.5 2.3Debt to equity 99.0 75.1 67.0 51.4 NA NAInternal sources of funds to total sources of funds 35.8 30.6 50.4 50.9 NA NABank borrowings to total borrowings 35.6 31.6 35.5 52.6 NA NA1 Data up to 2005-06 are based on audited balance sheet, while those for 2006-07 and 2007-08 are based on abridged financial results of the select non-government non-financial public limited companies.2 Growth rates are per cent changes in the level for the period under reference over the corresponding period of the previous year for common set of companies. 3 Sources: ‘RBI Studies on Company Finances and Performance of Private Corporate Business Sector during First Half of 2007-08’ (RBI Bulletin, January 2008).

SPECIAL ARTICLEEconomic & Political Weekly EPW may 10, 200865reform process has helped greatly in making the policy environment more conducive for more efficient entrepreneurial activity. The corporate tax rate was steadily reduced from 45 per cent in 1992-93 to 30 per cent by 2005-06 and was kept stable thereafter. The peak rate of customs duty on non-agricultural goods was reduced gradually from 150 per cent in 1991-92 to 10 per cent in 2007-08. Monetary policy has contri-buted to the sustained moderation in infla-tion leading to a reduction in nominal interest rates. Finan-cial restructuring of firms has also led to the reduction in over-all debt equity ratios in the corporate sec-tor. The substantial reduction in debt servicing costs has thereby added to the corporate sector’s competitiveness and profitability. Profits after tax recorded an annual average growth of around 47 per cent per annum over the four-year period ended 2006-07 (Table 5, p 64). Profit margins have recorded large gains, while the interest burden has witnessed a significant decline. In fact, the ratio of interest expenditure to sales revenues fell from around 6 per cent in the 1990s to about 2 per cent now, thereby contributing greatly to the enhanced profit growth. The profit after tax (PAT) to net worth ratio, after declining from 14.4 per cent in 1995-96 to 5.1 per cent in 2001-02, increased to 16.6 per cent 2005-06 (Table 6). Another notable feature of performance of the corporate sector in the recent period is the progressive increase in retained profits, which as a share ofPAT, increased from 30.9 per cent in 2001-02 to 73.6 per cent in 2005-06. The improved profitability, reflecting improved productivity and low-ering of tax rates, enabled corporates to deleverage their balance sheets. This was reflected in the sharp decline in the debt-equity ratio. The improved corporate financial performance resulted in a more than doubling of the private corporate sector saving rate (from 3.4 per cent in 2001-02 to 7.8 per cent in 2006-07), which has also contributed to the pick-up in the overall savings rate. From the long-term perspective, it is interesting to observe that the rate of savings of the private corporate sector has increased from around 1 per cent in the 1950s, 1.7 per cent in the 1980s and 3.8 per cent in the 1990s, to almost 8 per cent now. Higher retained profits along with availability of resources from the banking sector facilitated by the lower financing requirement of the government and the increased access to the domestic and international capital markets led to a sharp increase in the investment rate of the corporate sector from 5.4 per cent of GDP in 2001-02 to 14.5 per cent in2006-07. Thus, despite the increased savings rate, the sav-ing-investment gap of the corporatesector widened from 2.1 per cent of GDP in 2001-02 to 6.8 per cent in 2006-07. Household SavingsA remarkable feature of the Indian macroeconomic story since independence has been the continuous rise in household savings over the decades (Table 7). As might be expected, this rise has been characterised by a continuing increases in financial savings as a proportion of GDP. The spread of the financial sector, of bank branches in particular, post office savings and the like, helped in mobilising household financial savings. Their financial liabilities did not grow correspondingly since there were few financial prod-ucts available for household credit. This situation has changed in recent years with the introduction of new private sector banks, who introduced retail credit for housing and for consumer dura-bles in large measure. The public sector banks have followed suit.Hence, while gross financial savings of the household sector have continued their upward trajectory in the recent few years, households’ financial liabilities have also been increasing rapidly, albeit from a low base. Illustratively, gross financial savings grew from 13.8 per cent of GDP in 2004-05 to 18.3 per cent in 2006-07, while their financial liabilities rose from 3.8 per cent of GDP dur-ing 2004-05 to 6.8 per cent during 2006-07. The ongoing finan-cial deepening is facilitating larger access of bank credit for the households. As a result, household financial savings (net) have increased only marginally in the current decade – from 10.9 per cent ofGDP to 11.3 per cent during 2001-07. On the other hand, with increased availability of housing finance, the household sec-tor’s investment rate (physical savings) increased from 10.5 per cent in 1997-2003 to 12.7 per cent in 2003-07. Thus, the widening of S-I gaps of the public and private corporate sectors combined was partly financed from household financial savings and partly by foreign savings. This is reflected in a widening of the current account deficit from 0.4 per cent of GDP in 2003-04 to 1.1 per cent of GDP in 2006-07. Among the major sources of finance from abroad for the corporate sector, external commercial borrowings witnessed a turnaround from (-) 0.3 per cent of GDP in 2001-02 to around 1.7 per cent of GDP in 2006-07. Estimation of Savings and InvestmentIn view of the key role played by investment in the growth process,it is important to have reliable and timely estimates of domestic savings and investment. In India, methodologies of estimates of Table 6: Impact of Fiscal Policy on Corporate Performance (in %)Year Profit Tax Provision/ Retained Dividends/ after Tax (PAT)/ Profit Profits/ PAT Net Worth Net Worth before Tax 1 2 3 4 51980-81 14.2 43.8 61.85.41990-91 13.5 32.4 62.85.01991-92 12.0 36.5 62.24.51992-93 8.7 33.3 53.9 4.01993-94 12.0 23.7 67.63.91994-95 14.0 20.2 72.23.91995-96 14.4 19.7 73.6 3.81996-97 9.5 27.8 64.03.41997-98 7.6 26.363.02.81998-99 5.6 31.4 52.32.71999-00 6.3 33.2 47.63.32000-01 6.5 32.3 48.83.32001-02 5.1 36.7 30.9 3.52002-03 8.7 31.3 56.33.82003-04 12.3 28.7 64.7 4.62004-05 15.9 25.9 73.1 4.52005-06 16.6 25.4 73.6 4.6Source: Study of Company Finances, Reserve Bank of India.Table 7: Savings and Investment Rates of the Private Sector (% of GDP) Item 1950s 1960s 1970s 1980s 1990-91 1991-92 to 1997-98 to2003-04 to 1996-97 2002-03 2006-07 1 2 3 4 5 6 7 8 9Household savings 6.6 7.6 11.4 13.5 18.4 16.8 20.8 23.8 Financial savings 1.9 2.7 4.5 6.7 8.7 10.0 10.3 11.1 Physical savings 4.7 4.9 6.9 6.8 9.7 6.8 10.5 12.7Private corporate savings 1.0 1.5 1.5 1.7 2.7 3.7 4.0 6.6Private corporate investment 1.9 2.9 2.6 4.5 4.5 7.7 6.6 11.2Memo: saving-investment gap Household sector 1.9 2.7 4.5 6.7 8.7 10.0 10.3 11.1 Private corporate sector -0.9 -1.5 -1.0 -2.8 -1.8 -4.0 -2.6 -4.7 Publicsector -2.6 -4.1 -4.4 -6.9 -8.2 -6.5 -7.5 -4.9

SPECIAL ARTICLEmay 10, 2008 EPW Economic & Political Weekly66savings and investment have evolved over the years in tune with the international guidelines and improvements in the domestic statistical system in India. Nonetheless, there is a need to criti-cally review the available estimates of savings and investment in the Indian economy with respect to data base, methods of esti-mation, reliability and interpretational significance. The compi-lation of savings of the household sector continues to pose a chal-lenge in view of the heterogeneity and residual character of this sector in the national accounts. In respect of the household finan-cial savings, there is a need to assess whether the current state of financial deepening is being accurately reflected in the data across the various financial instruments. In this regard, the timely compilation of the flow of funds accounts would go a long way in accurately estimating household financial savings. The feasibility of directly estimating household savings through integrated income and expenditure sur-veys also merits consideration. In respect of the private corporate sector, there is a need to examine whether it wouldbe appropriate to make their savings esti-mates on marked to market basis or the present value book method. In respect of the public sector, the savings and invest-ment estimates can be further strength-ened by improving the coverageto include municipalities, city corporations, gram panchayats and other local gov-ernments on the one hand and increased private participation in public invest-ments on the other. The High Level Committee on Estimation of Savings andInvestment (chaired by C Rangarajan) is expected to critically review the existing methodologies to review esti-mates of saving and investment for the Indian economy.Efficiency in the Use of ResourcesNot only has there been a consistent upward trend in India’s investment rate since the 1950s, there is evidence that cap-ital has been employed productively. Bar-ring the decade of the 1970s, the incre-mental capital output ratio (ICOR) has hovered around 4. There are some signs of improvement in domestic productivity in the post-reforms period. Cross-country comparison indicates thatICOR has been amongst the lowest in India. This is espe-cially true of the period since the 1980s onwards (Table 8). Various reform measures aimed at increasing competitiveness appear to be having the desired impact on the productivity of the Indian economy.As noted above, the improvement in public finances and public sector savings has contributed significantly to the step-up in domestic savings and investment rates since 2002-03 onwards. Higher savings and investment rates, in turn, have led to a higher growth trajectory of the Indian economy. It is apparent that fiscal consolidation in the Indian context has led to acceleration of growth. The conventional view holds that fiscal prudence might lead to contraction of domestic demand and growth. However, as the Indian experience suggests, fiscal prudence can lead to higher domestic savings and this could increase resources for domestic investment. Accordingly, it is of utmost importance to adhereto the fiscal consolidation process of the past few years so as to sustain current savings/investment rates and the ongoing growth momentum. While containment of fiscal deficits is important, the quality of fiscal adjustment is also critical. It is necessary to persevere with the process of reprioritising public expenditures towards public investment vis-à-vis subsidies. While subsidies may provide short-term benefits, they tend to hinder long-term investments as well as encourage inefficiency in the use of resources. These issues are important in the context of agricultural development, especially in the context of domestic demand-supply gaps of major crops and elevated international prices. Public investment in agriculture declined from 3.4 per cent of agriculturalGDP during 1976-80 to 2.6 per cent during 2005-06, while budgetary subsidies to agriculture increased from 3 per cent (1976-80) to 7 per cent of agriculturalGDP (2001-03). Therefore, greater emphasis on stepping up public investment and containment of subsidies, while adhering to fiscal consoli-dation, is likely to pay rich dividends. It would not only engender currentgrowth impulses but also contribute to food security and domestic price stability.Financial Sector ReformsThe higher order of investment activity in the country over the past few years has also been mirrored in strong demand for credit from the banking sector since 2003-04 onwards. In this context, reforms in the financial sector have played a key role [Mohan 2006a, 2007b]. Financial sector reforms, initiated in the early 1990s, encompassed introduction of auctions in government securities, deregulation of interest rates and reduction in statutory pre-emption of institutionalresources by the government was car-ried forward with the phasing out of the system of automatic monetisation of fiscal deficits from1997-98.Thesemeasures along withdevelopmentsin the government securities market, by making the yield market-determined, formedthe backbone of financial market reforms. Apart from making the interest rates largely market determined, reforms included a market-deter-mined exchange rate (though accompaniedbyRBI forex inter-vention), current account convertibility,substantialcapital Table 8: Growth, Investment and ICOR – Select CountriesCountry 1960s 1970s 1980s 1990s 2000-06 1 2 3 4 5 6Real GDP growth (%) Brazil 5.9 8.5 3.0 1.7 3.1China 3.0 7.4 9.8 10.09.5India 4.0 2.9 5.6 5.7 7.0Indonesia 3.7 7.8 6.4 4.8 4.9Korea 8.3 8.3 7.7 6.3 5.2Mexico 6.8 6.4 2.3 3.4 2.9Philippines 5.15.82.02.84.8South Africa 6.1 3.3 2.2 1.4 4.1Thailand 7.87.57.35.35.0Real investment rate (% of GDP) Brazil 15.318.116.416.915.8China 23.735.937.440.141.4India 16.9 19.420.2 23.328.1Indonesia 8.917.929.633.122.7Korea 12.821.027.435.629.4Mexico 25.926.220.120.422.1Philippines 19.923.321.622.920.7South Africa 16.0 20.0 17.8 14.9 17.2Thailand 26.831.530.236.422.6ICOR Brazil 2.6 2.1 5.5 9.9 5.1China 7.9 4.8 3.8 4.0 4.3India 4.3 6.6 3.6 4.1 4.0Indonesia 2.4 2.3 4.6 6.9 4.7Korea 1.5 2.5 3.6 5.7 5.7Mexico 3.8 4.1 8.8 6.0 7.6Philippines 3.9 4.0 10.7 8.2 4.3South Africa 2.6 6.2 8.0 10.7 4.2Thailand 3.44.24.16.94.5Source: World Development Indicators, World Bank.

Private Corporate Sector Public Sector

SPECIAL ARTICLEmay 10, 2008 EPW Economic & Political Weekly682004-05.Thesaving-investment gap was projected to be financed through an increase in household financial savings rate by around 1 percentage point, ie, to 11.4 per cent of GDP from 10.3 per cent in 2004-05. The remaining portion of the saving-investment gap was projected to be financed from the rest of the world sector through a widening of current account deficit by around 1-2 per-centage points, i e, to a range of 2.1-2.8 per cent of GDP from 1 per cent in 2004-05. Against this backdrop, there is a need to factor in the latest available information to assess as to what holds for future pros-pects. According to the quick estimates released by the Central Statistical Organisation (CSO) in January 2008, the realGDP growth is estimated to have accelerated to 9.6 per cent in 2006-07 from 9.4 per cent in 2005-06 and 7.5 per cent in 2004-05. The acceleration in growth has been supported by the rise in invest-ment rate from 32.2 per cent in 2004-05 to 35.9 per cent in 2006-07, in turn, supported by the rise in domestic saving rate from 31.8 per cent to 34.8 per cent. Accordingly, the S-I gap widened from (-) 0.4 per cent of GDP in 2004-05 to (-) 1.1 per cent in 2006-07. As the previous analysis shows, sustenance of the growth momentum would hinge upon the continued progress in public finances, enhanced role of the private corporate sector and fur-ther deepening of the financial sector to boost household finan-cial savings. Apart from domestic factors, it is increasingly being recognised that global factors would play a far greater role than before in view of progressive opening up of the Indian economy resulting in greater financial integration over and above the tra-ditional trade integration. The factors which would merit attention in drawing prospects for the public sector include the progress in public finances in the remaining period under theFRBM Act and beyond, the scope and scale of the likely impact of the Sixth Pay Commission (SPC) award and streamlining of expenditures. Available information for 2007-08 shows continued buoyancy in taxes with impressive growth shown in respect of income tax, corporation tax, customs duty, service tax and new taxes. Assuming that the central gov-ernment meets its FRBM targets by 2008-09 and the states also adhere to their fiscal responsibility legislations targets, supported by the ongoing tax buoyancy and appropriate expenditure man-agement, the dissavings of government administration could be expected to reduce further from Rs 55,811 crore (1.3 per cent of GDP) in 2006-07 to levels consistent with the achievement of the target of 0 per cent of GDP in respect of the revenue deficits for both the centre and the states. As noted earlier, the saving rates of the non-departmental undertakings which were maintained at around 4 per cent of GDP and that of departmental enterprises at around 0.6 per cent during 2002-07 are likely to prevail in the coming five years.Some risks to these prospects, however, can be perceived from the implementation of the SPC award. According to the SPC report, gross implications of its various recommendations are estimated at Rs 12,561 crore (about 0.27 per cent of GDP for 2007-08). At the same time, some of the recommendations will lead to savings of Rs 4,586 crore. The net additional impact is, thus, estimated at Rs 7,975 crore (about 0.17 per cent of GDP for 2007-08). Arrears for 2006 and 2007 are expected to amount to Rs 18,060 crore (0.38 per cent of GDP in 2007-08), which the SPC has recommended could be paid over a period of two years. Based on these data, the annual impact (gross) of the SPC award could be around 0.5 per cent ofGDP in the first two years (inclusive of the arrears), which would reduce to below 0.3 per cent from the third year onwards. However, an assessment of the impact of the report requires a more detailed assessment of the implications of the commission’s recommendations and of the final decisions that the government takes. In this context, it is also instructive to examine the experience of the FPC award, which was implemented from 1997-98. The liability of the central government as a result of implementing theFPC award was estimated at Rs 18,500 crore up to the end of February 1998. The impact was spread over the period from 1997-98 to 2000-01, rather than being a mere one-off impact in 1997-98. The proportion of wages, salaries and pensions of the central government, as a proportion of GDP, which had increased from 2.7 per cent in 1996-97 to 3.3 per cent for three years up to 2000-01, tapered-off back to about 2.7 per cent by 2003-04. Thus, the impact of theFPC approximately amounted to about 0.6 per cent ofGDP per annum over a four-year period – a cumulative impact of 2.4 per cent – for the central government. The impact of SPC recommendations, prima facie, appears to be somewhat lower than that the actualFPC impact, but a full assessment will have to be done on a detailed examination of its implementation. In respect of the state governments, in the absence of budgetary data on salary expenditure, the impact ofFPC can be ascertained from its proxy taken as the non-plan revenue expenditure in social, economic and administrative services. The impact was visible from the year 1999-2000 when the proxy indicator as a proportion to GDP rose from 6.6 per cent in 1998-99 to 7.0 per cent in 1999-2000 and 7.2 per cent in 2000-01, before declining back to 6.7 per cent in 2001-02. Thus, the impact of FPC for the states amounted to approximately 0.4-0.6 per cent of GDP (a cumulative impact of 1.0 per cent over the two-year period). The combined impact of the centre and states, thus, approximated to around 1.0 per cent of GDP (a cumulative impact of 3.4 per cent). In order to absorb the impact of FPC, the govern-ment envisaged to bear it through a combination of additional resource mobilisation and expenditure reducing measures. However, as alluded to above, there was a decline in the tax-GDPratioin the late 1990s, which exacerbated impact on the government finances. Looking forward, and taking into account the SPC report, the pressures on expenditures may amount to slightly less than 1.0 per cent ofGDP per annum for the centre and states combined, spread over a three-four year period. Unlike the prevailing situa-tion during the FPC, the SPC implementation would be under-taken when the economy is witnessing high tax buoyancy – the tax-GDP ratio of the centre has increased by 2.6 percentage points to 11.3 per cent in 2006-07(RE) from 8.8 per cent in 2002-03. In the interest of continuing with the growth momentum, it is essen-tial that the impact of theSPC be absorbed without impairing the process of fiscal consolidation. In view of the buoyancy of direct taxes and service taxes at the central level, and of VAT at the state

SPECIAL ARTICLEEconomic & Political Weekly EPW may 10, 200869level, there is an opportunity this time to accomplish this at both central and state levels. Continuation of efforts at improving tax compliance, renewed efforts at containing subsidies, and levy of appropriate user charges to augment non-tax revenues, would all need to be used to comply with theFRBM.As regards the prospects for the private corporate sector, there are incipient signs of some deceleration in the growth of net profits from the strong pace of the past four years; nonetheless, growth in corporate profitability still remains buoyant and is well-above the nominalGDP growth. At the same time, cogni-sance needs to be taken of growing competition, both internal and external, in the domestic economy. Furthermore, the early benefits of reforms reaped by the corporate sector, especially by deleveraging of balance sheets, may not be available at the same scale in future. Thus, it may be reasonable to assume that the corporate savings rate, which had doubled to 7.8 per cent of GDP during the period 2002-07, may exhibit some plateauing in the coming few years but should not be expected to fall. Regarding the household sector, the quick estimates indicate that financial savings stagnated at around 11.3 per cent of GDP during 2006-07, while the physical saving rate moderated some-what, but remained higher than financial savings at 12.5 per cent of GDP in 2006-07. Bank deposits constitute the largest propor-tion of household financial savings and their share in total, which fell during the 1980s, has been recovering since the 1990s (Table 9). The buoyancy in bank deposits over the past year – growth of around 23.8 per cent, year-on-year, as of January 2008 – partly reflects some migration from small savings; as this signifies only a shift in the asset portfolio composition of house-holds, the recent buoyancy in bank deposits is not suggestive of an uptrend in overall household financial savings. The improvement in financial savings would depend on the further deepening of the financial sector, particularly through the con-tinuation of insurance and pension reforms. Assuming the tax structure to remain stable over the coming five years, the growth of financial savings is likely to maintain its pace with the growth in nominal income. Thus, based on the emerging trends, it is reasonable to expect that both the household financial savings rate and the corporate saving rate would be broadly maintained at around their current rates of around 11 per cent and 8 per cent, respectively. On the other hand, improvement in the public sector savings rate may be hampered by the impact of theSPC, but it should not be expected to fall. On balance, the overall GDS rate may improve somewhat in 2008-09, ie, the terminal year ofFRBM, led by the public sector and remain around that level in the next three years. 3 IssuesandChallenges What have we learned from this review of Indian economic growth and macroeconomic management over the past 50-60 years? How do we go forward to ensure the continuation of the growth momentum achieved in recent years?First, Indian economic growth has been largely enabled by the availability of domestic savings. The continuous acceleration of its growth over the decades has been accompanied by a sustained increase in the level of domestic savings, expressed as a propor-tion of GDP. Moreover, interestingly, despite all the shortcomings and distortions that have existed in the evolving financial sector in India, the efficiency of resource use has been high with a long term incremental capital output ratio (ICOR) of around 4, which is comparable to the best achieving countries in the world. Hence, in order to achieve 10 per cent+ growth, we will need to encour-age the continuation of growth in savings in each of the sectors: households, private corporate sector, public corporate sector and the government.Second, the recent acceleration in growth has been enabled by a surge in private sector investment and corporate growth. This, in turn, has become possible with the improvement in fiscal per-formance reducing the public sector’s draft on private savings, thereby releasing resources to be utilised by the private sector. For the growth momentum to be sustained, it will therefore be necessary to continue the drive for fiscal prudence at both the central and state government levels.Third, the generation of resources by the private corporate sec-tor through enhancement of their own savings has been assisted greatly by the reduction in nominal interest rates, which has become possible through a sustained reduction in inflation brought about by prudent monetary policy. Indian inflation, though low now by our own historical standards, is still higher than world inflation, and hence needs to be brought down fur-ther. It is only when there is a further secular reduction in infla-tion and inflation expectations over the medium term that Indian interest rates can approach international levels on a consistent basis. Hence, it is necessary for us to improve our understanding of the structure of inflation in India: how much can be done by monetary policy and how much through other actions in the real economy so that leads and lags in supply and demand in critical sectors can be removed, particularly in infrastructure. Suste-nance of high levels of corporate investment are crucially condi-tioned by the existence of low and stable inflation enabling low and stable nominal and real interest rates.Fourth, whereas fiscal correction has gained a credible momen-tum in recent years, some of it has been achieved by reduction in public investment. Whereas a desirable shift has taken place from public to private investment in sectors essentially producing private goods and services, and there is a move toward public-private partnerships in those which have both public good and private good aspects, it is necessary to recognise that public Table 9: Shares of Components of Household Financial Savings (in %) 1970s 1980s 1990-91 1991-92 to 1997-98 to 2003-04 to 1996-97 2002-03 2006-07 1 2 3 4 5 6 7Currency 13.9 11.9 10.610.9 8.6 9.3Bank deposits 45.6 40.3 31.9 33.1 38.5 44.0Non-banking deposits 3.0 4.6 2.2 9.4 2.9 0.7Life Insurance Fund 9.0 7.5 9.5 9.5 13.1 14.6Provident and Pension Fund 19.6 17.5 18.9 17.6 19.0 11.4Claims on Government 4.2 11.1 13.4 7.1 14.9 16.9Shares and Debentures 1.5 3.9 8.4 8.3 3.7 3.9Units of UTI 0.5 2.2 5.8 5.0 0.1 -0.8Trade Debt (Net) 2.7 0.9 -0.8 -0.8 -0.7 0.0Total Financial Saving (Gross) 100.0 100.0 100.0 100.0 100.0 100.0Source: Handbook of Statistics on the Indian Economy, RBI, 2006-07.

SPECIAL ARTICLEEconomic & Political Weekly EPW may 10, 200871relatively low. Moreover, a significant segment of the population remains excluded from banking services. As the growth process strengthens and becomes more inclusive, it is expected that demand for financial products could continue to witness high growth in the coming years. Thus, it is likely that growth in bank credit and monetary aggregates could be higher than what might be expected from historical relationships and elasticities in view of ongoing structural changes. This, however, raises critical issues for the central bank such as the appropriate order of monetary/credit expansion. In the absence of a yardstick, excessive growth in money supply could potentially show up in inflationary pressures over course of time, given the monetary lags. Indeed, recent inflationary pressures across the globe are attributable, in part, to global liquidity glut. In the absence of inflationary pressures as conventionally measured, excessive money and credit growth could also lead to asset price bubbles, with adverse implications for banking sector stability and lagged conventional inflation. Thus, the RBI will have to face ongoing challenges to provide appropriate liquidity to the system so as to ensure growth in non-inflationary environment. This raises the critical issues of clarity in reading signs of inflation, asset prices and systemic liquidity from monetary/credit expansion.On the sectoral phase, a key issue is that of agricultural growth. In fact, the historical review suggests strongly that the periods of slow overall growth have invariably been characterised by slow agricultural growth, even in recent years when the weight of agriculture inGDP has reduced considerably.The Eleventh Five-Year Plan projects the sectoral growth rates at around 4 per cent for agriculture, 10 per cent for the services sector and 10.5 per cent for industry (with manufacturing growth at 12 per cent). While the targets for industry and services sectors are achievable, sustaining agricultural growth at around 4 per cent for achieving the growth target of 9 per cent during the Elev-enth Plan would be a major challenge, particularly because this sector is constrained by several structural bottlenecks such as technology gaps, timely availability of factor inputs, lack of effi-cient markets for both inputs and outputs as well as continued policy distortions. Notwithstanding some improvement in agri-cultural performance in recent years, production and productiv-ity of major crops continue to be influenced by rainfall during the sowing seasons. Therefore, apart from institutional support, the immediate requirement is to improve irrigation facilities through higher public investment and augment the cropped area as well as yields through various other methods. This will need public investment and better management [Mohan 2006b].Improved agricultural performance is not only important forsustaining growth but also for maintaining low and stable inflation. Volatile agricultural production and lower food stocksinternationally are beginning to raise growing concerns about rising food prices influencing overall inflation both globally and in India. In the medium term, therefore, efforts would have to be directed towards not only improving the cropyields but also putting in place a market driven incentive system for agri-cultural crops for a durable solution to address the demand-sup-ply mismatches and tackle food inflation. Sustained improve-ment in crop yields requires an enhanced focus on the revitalisa-tion of agricultural research, developmental extension. Coming to infrastructure, the Planning Commission has esti-mated that infrastructure investment ought to grow from the current levels of around 4.6 per cent of GDP to 8 per cent for sus-taining the 9 per cent realGDP growth as envisioned in the Elev-enth Plan. Thus, investment in infrastructure is expected to rise by over 3 percentage points of GDP over the Plan period; over the same period, the Planning Commission anticipates that overall investment rate of the Indian economy should grow by 6 percent-age points. In other words, almost one half of the total increase in overall investments is expected to be on account of the infra-structure requirements. For such an increase in infrastructure investment to take place over the Plan period, both public sector and private sector investment will need to grow much faster than in any previous period.Sustained growth in private sector infrastructure invest-mentcan take place in only those sectors that exhibit adequate return, either on their own or through public-private partner-ships. The performance of the telecom sector has exhibited thisconvincingly. A renewed focus on the levy of adequate user charges is therefore necessary, and policy measures that provide stability to the flow of infrastructure revenues [Mohan2004].In this context, it needs to be recognised that the use of foreign currency denominated borrowings to fund domestic infrastruc-ture projects runs the risk of currency mismatches in view of the fact that earnings of such projects are in domestic currency. Thus, large, unanticipated currency movements can render unviable such projects, thereby endangering future investments. Caution therefore needs to be exercised in the foreign funding of infra-structure projects, unless appropriately hedged.ReferencesDe Long, B (2003): ‘India Since Independence: An Analytic Growth Narrative’ in D Rodrik (ed),In Search of Prosperity: Analytic Narratives on Economic Growth,Princeton University Press, New Jersey.Henry, Peter Blair (2007): ‘Capital Account Liberalisa-tion: Theory, Evidence, and Speculation’,Journal of Economic Literature, Vol XLV, December.Mohan, Rakesh (2004): ‘Infrastructure Development in India: Emerging Challenges’ in Francois Bour-guignon and Boris Pleskovic (ed), Annual World Bank Conference on Development Economics: Accel-erating Development, Oxford University Press and World Bank. – (2006a): ‘Financial Sector Reforms and Mone-tary Policy: The Indian Experience’,RBI Bulletin, July.–(2006b): ‘Economic Reforms in India: Where Are We and Where Do We Go?’, RBI Bulletin, December. – (2007a): ‘Capital Account Liberalisation and Con-duct of Monetary Policy: The Indian Experience’, RBI Bulletin, July. – (2007b): ‘India’s Financial Sector Reforms: Foster-ing Growth While Containing Risk’,RBI Bulletin, December.Panagariya, Arvind (2004): ‘India in the 1980s and 1990s: A Triumph of Reforms’, IMF Working Paper WP/04/43.Prasad, Eswar S, Raghuram G Rajan and Arvind Subramanian (2007): ‘Foreign Capital and Eco-nomic Growth’,Brookings Papers on Economic Activity, 1.Rodrik, Dani and Arvind Subramanian (2004): ‘From “Hindu Growth” to Productivity Surge: The Mys-tery of the Indian Growth Transition’, IMF Work-ing Paper WP/04/77.Reserve Bank of India (2007): ‘Annual Policy State-ment for 2007-08’.– (2008): ‘Third Quarter Review of the Annual Statement on Monetary Policy for 2007-08’.Virmani, Arvind (2004): ‘India’s Economic Growth: From Socialist Rate of Growth to Bharatiya Rate of Growth’, Working Paper 122, ICRIER.