It does not require a lengthy government report to tell us that India is “entering a new phase of high growth”or that there are “genuine concerns on inflation”. We want to know: Why? Or, at least, what do the country’s economic authorities think are the factors driving output and inflation.
There is precious little by way of quality economic analysis in the Economic Survey released on Tuesday to explain why the growth rate has suddenly accelerated in the past few years. Is it the result of a wider global boom fuelled by cheap money? Or is it a largely domestic success story? Is growth being driven by higher productivity? Or has the celebrated demographic transition done its trick? The survey offers no explicit answers to these larger questions, nor does it attempt to.
But important clues about the nature of the economic boom lie hidden in this vast report. These clues suggest that the current surge in growth is sustainable, with the gradual change in the Indian economic model—from being fuelled by consumption to being fuelled by investments.
Critics often point out that our economic growth is based on consumption rather than investment, in sharp contrast to East Asia and China, where rapid growth was driven by investment. The unstated thrust of this argument is that growth in India is unsustainable, as investment, rather than consumption, builds up future production capabilities.
This criticism no longer holds, as the balance between the two main drivers of growth has changed remarkably over the past three years. The Survey is not the first report to make this point. Many economists have already commented on this transition, but it is a story worth repeating.
Private consumption accounted for more than half of economic growth till 2001-02. It then dropped to less than half in the next year, before rising again. There have been years such as 1997-98, when consumption accounted for more than 90% of economic growth since the government gave huge salary hikes to its employees and private investment collapsed in the aftermath of the Asian crisis of 1997. In some of these years, the economy resembled an aircraft flying on one engine, with the attendant risks. Now, both engines are firing with equal gusto. Investment has taken over from consumption as the main engine of economic growth, contributing more than half of it since 2004-05. The change in the economic model is fortuitous at this stage of the business cycle when factories are running at close to full capacity and infrastructure constraints threaten future growth.
Underlying this is the growth in savings and investment. The savings rate has shot up from around 24% of GDP through the 1990s to 32.4% today. Investment rates are up at 33.8%. But as investments are higher than savings by around 1.4% of GDP, we have a growing current account deficit. So, foreign savings are needed to cover the growing savings-investment gap. Unless a higher current account deficit can be sustained (there is no reason to believe it can), India needs more savings to take its growth a few notches higher, to around 10%. One way is to raise government savings with a lower fiscal deficit. At the same time, India needs more reforms and a less distortionary tax structure to ensure that these higher savings are not frittered away, as China is sometimes accused of doing.
A lower fiscal deficit, more competition in product markets and a better tax structure are the big issues to be tackled in today’s Union Budget.
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