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India flying on one engine

India flying on one engine
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First Published: Thu, Jul 02 2009. 11 23 PM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Thu, Jul 02 2009. 11 23 PM IST
The government’s new Economic Survey for 2008-09 tells us in stark and numerical terms what most economists, business people and investors instinctively knew. High government spending supported domestic demand, as shell-shocked consumers and companies withdrew into their shells after the global economic crisis went from bad to worse after September 2008.
Illustration: Jayachandran / Mint
This rescue operation was timely, but it can endanger future growth and stability if the government does not cut extra spending when the economy eventually settles down. This is the much-discussed fiscal exit strategy. Then, consumers and companies will have to fill the demand vacuum.
In any economy, there are four sources of demand: from consumers, the government, investment spending and net exports.
Thus, think of the economy as a plane powered by four engines. Which engine does most of the work depends on the weather. Is it clear as in 2007 or turbulent as in 2009?
Net exports rarely matter in an economy such as ours where domestic demand is king. However, the relative importance of the three parts of domestic demand --- consumer spending, government spending and investment activity --- keeps changing.
What happened in the past few years? Investment spending measured by gross capital formation accounted over half of total growth through most of the five-year economic boom.
Private and government consumption were relatively less important growth drivers in those years.
But everything changed in 2008-09. The contribution of gross fixed capital formation to Indian economic growth was 42.5%. The contribution of private consumer spending collapsed from 53.8% in 2007-08 to 27% in 2008-09. In contrast, the contribution of government consumption shot up from 8% to 32.5%.
In short, the huge rise in government spending in the last financial year prevented an economic collapse.
But this steep rise in public spending is bound to pull down the national savings rate which can finance future growth. (The savings data for 2008-09 is not yet available. Public sector savings is one component of gross domestic savings.)
Fiscal pump priming can only be a temporary palliative. The government now needs to create conditions for a revival in consumer and corporate spending through economic reforms.
Thus, fiscal correction and radical reforms are finance minister Pranab Mukherjee’s two big tasks on Monday, when he unveils the Union budget.
Does India need a reforms push or a fiscal push? Tell us at views@livemint.com
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First Published: Thu, Jul 02 2009. 11 23 PM IST