The Indian economy doubled in size in five short years.
The value of economic output in FY12 would be just short of the $2 trillion mark, according to a report released by the Prime Minister’s economic advisory council (EAC) on Monday. The doubling of the size of the economy in dollar terms has been helped by two factors—a high rate of nominal gross domestic product (GDP) growth and a stable exchange rate. Yet, the broad trend indicates that strong economic growth in recent years is increasing India’s economic heft. Average annual incomes have also doubled to an estimated $1,664, a development that must have benefited most income groups despite a mild rise in inequality.
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It is now eight years since the rate of economic growth accelerated in FY04. India needs to maintain current growth rates, and perhaps even better then, for at least the next 20 years if it is to abolish mass poverty and offer citizens a decent chance to lead a good and productive life. Very few countries have been able to maintain such high rates of economic growth for long periods of time. There are too many examples of countries that have had impressive take-offs and then had sudden crash landings, most notably in Latin America after the 1970s.
India may not go the Latin American way, most significantly because our fiscal deficits are financed cheaply by domestic savings because of financial repression, through which a quarter of bank deposits have to be used to buy government bonds at very low real interest rates. But the risks of a growth recession, or economic expansion that is modest compared with potential, are growing.
Much of the current discussion on growth and inflation is focused on cyclical trends, with the almost religious belief that there is nothing structurally wrong with the Indian economy. It was time this belief was torpedoed. In its latest monetary policy statement, the Reserve Bank of India has already pointed out that its battle against inflation would be a limited success unless the government acted to increase the productive potential of the economy.
The splendid jump in economic growth after FY04 had the solid foundation of a secular increase in the rates of domestic savings and investments, each of which increased by 10 percentage points of GDP in the early years of this century, adding around 2.5 percentage points to the potential growth rate of the Indian economy.
The rise in savings was driven by two underlying trends. First, corporate savings increased as companies reaped the benefits of the hard work done to increase productivity and improve their finances in the 1990s. Second, government savings increased because of more tight budgets.
Both trends reversed after the global financial crisis of 2008, especially the trend in government savings. The government ran up a large fiscal deficit in FY10 in an attempt to support domestic demand after private investment and consumption activities were hit. But the return to a better fiscal balance since then has been poor; in fact, the increased commitments to various entitlement programmes and a growing subsidy bill continue to pull down national savings and reducing the pool of money available for investment activity.
Various measures of investment show how national savings and investment rates are around 2-3 percentage points below the pre-crisis highs. That alone can pull down the rate of economic growth by around 0.75-1 percentage point, says EAC in its report. The investment scenario has also been clouded by high inflation and policy paralysis, both of which make it difficult for companies to invest in large projects. Then there are the infrastructure bottlenecks that hold back economic activity.
The warning signals have been flashing for the past two years, but the government has been too busy using its political capital chasing ambitious schemes that could strain both public finances and state capacity. There is no doubt that the poor need state support, but the way the United Progressive Alliance has gone about the essential task is not commendable.
I have said this before: what India needs right now is not a fiscal push, but a reforms push. There does seem to be some twitches of movement in recent weeks, from the decision to raise domestic fuel prices, make some tentative moves towards opening up the retail sector to foreign investment, appointing Sushil Modi to head the goods and services tax panel, clearing the Cairn-Vedanta and Reliance-BP deals, and preparing a draft Bill for land acquisition, for example.
The only fear is that this may be too little and too late at a time when the main roadblocks to faster growth and lower inflation are structural rather than cyclical. The lack of economic reforms since 2004 has now come to hurt the country, two decades after the reforms of 1991 energized a moribund and crisis-ridden economy.
Niranjan Rajadhyaksha is executive editor of Mint. Comments are welcome at firstname.lastname@example.org