It has become commonplace to see many senior government officials and ministers confidently predict a double-digit growth rate for the Indian economy in the near future. They must exhale. India is not ready for it yet, not based on what they have done so far, in the last six years. It is not impossible. But they must work at it.
There are many reasons for India to pursue a high growth rate. One, China’s growth rate continues to remain high and is a source of pride for that nation and admiration for the rest of the world. Two, not just China, but all of the East Asian tiger economies were, at one stage or the other, fast growing economies. So if one were an Asian nation, then one has to grow fast. Growth has become an obsession with many states—big or small. India is proving to be no exception.
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There are two aspects to any growth objective. One is not to deviate too far from the potential growth rate as it stands—neither too much below nor too much above it for too long, and the second is to keep improving the potential growth rate of the economy. Currently, the Indian government’s growth strategy is failing on both counts. Well, at least, until very recently.
In its annual report for the year ended June 2009, the Reserve Bank of India estimated India’s potential gross domestic product growth to be around 8% and attributed it to “investment spurt and reform related productivity gains”. There was no substantiation of these causal factors.
If the sustainable growth rate of the economy was 8% according to the country’s central bank, targeting a growth rate of 9% or above is an invitation for a rise in prices. That is what is happening now in India. Despite the attempt to pass off the spike in prices as food- and agriculture-related, non-food inflation is running at a rate of above 7%. Overall inflation, as indicated by official consumer price indices, with all their flaws, has been running well above 10% for quite some time now.
Despite the fact that economic growth up to 2008 was driven by gross fixed capital formation and that it was accompanied by an improvement in the government’s fiscal balance in that period, the spike in the inflation rate and its persistence confirm that capital formation did not alleviate India’s supply bottlenecks either by adding to installed capacity or improving utilization of existing capacity.
The annual compounded growth rate in the output of the six infrastructure industries was 6.7% during the five-year period ended March 2008. It was at a time when the Indian economy grew at a 9% rate. The mismatch has only worsened further. The trailing annual growth rate in the output of these industries for the five-year period ended March has further decelerated to little over 5% now. This places a cap on the sustainable growth that the economy can achieve.
Much of the confidence about India’s growth potential comes from the growth dividend anticipated from the large young population. That the demographic dividend would automatically help to deliver 9%-plus growth rate would turn out to be misplaced for the long term as it is, for the present. TeamLease’s annual report (2009) on the Indian labour market covers in detail the mismatches in education, geography and sectors between what employers want and what India’s labour pool has to offer either now or in the future, based on a continuation of current trends. Without reforms in education and in the labour market, India would fail to realize the demographic dividend.
Let us be clear. These lacunae do not weaken India’s case for a high growth rate. An 8% annual growth is very respectable these days. India’s high savings rate and better capital efficiency would ensure this outcome with little difficulty. However, instead of settling for it while, at the same time, working on enhancing the economy’s growth potential, the government is likely to take it up on itself to propel such growth through government expenditure geared towards redistributive policies. The National Food Security Act is an example.
It would raise regular market prices with the supply ostensibly diverted to the public distribution system, only for it to find its way back into the open market to be sold at the prevailing higher prices. This would boost the inflation rate and leave the poor more impoverished. In the meantime, the higher subsidy outgo would count towards economic growth with neither equity nor efficiency achieved.
Instead, the government should add to and follow through on its recent initiatives in energy pricing, national litigation and land titling with reforms in education, agriculture, labour market and, more importantly, in governance.
India needs both high growth and high quality growth. If the government were intent on delivering the former now, in future, India would enjoy neither. We need to be asking a lot of questions of the government now rather than later.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views.
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