The Indian economy underwent two important transitions in 2009-10, even as it rebounded smartly despite the worst drought in two decades and a stuttering global recovery.
The first transition is of immediate interest, as it tells us a lot about the strength of the economic recovery and the state of the business cycle.
The good news here: Indian economic growth at the end of the last fiscal year was no longer dependent on government support alone. The downturn that came in the wake of the Western financial crisis saw a collapse in private sector activity. The Indian government had already boosted spending a year ahead of the national elections in May 2009, and this politically inspired profligacy—later cleverly repackaged as a stimulus programme —kept domestic demand and economic growth on track though it blew a hole in public finances.
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As with most other countries, government spending was a major driver of Indian growth during the downturn, with net exports also contributing a fair chunk in some quarters, thanks to the savage import compression seen in the last three months of 2008 and the first three months of 2009.
The key task right now is to shift away from dependence on government spending and towards a greater role for private consumption and investment. The fourth quarter national output numbers released by the government on Monday offer some good news on this score. Almost half the economic growth in the fourth quarter of the last fiscal year came from investment activity. Net trade accounted for another third. The contribution of government final consumption spending was a slim 2.2%.
The pickup in investment activity between January and March and the earlier reduction in inventory suggest that industrial recovery is well on track. Investment activity too has been growing smartly. The nature of this economic recovery is in sharp contrast to the bounceback we saw in India after the Asian economic crisis of 1997 and 1998. The recovery then was led by private sector consumption spending rather than investments. It took India at least five years from that trough before capital spending accelerated after 2003.
That we seem to be leaving the recent downturn on the back of robust investment growth is an indication of the strength of the current recovery.
One issue that needs to be watched with care is whether there are enough domestic savings to fund the investment acceleration. I had pointed out in an earlier instalment of this column that household savings are unlikely to cover more than half of the $35 billion or so of fresh capital that large companies will need in this fiscal year, thus making them dependent on volatile foreign capital flows (see Café Economics, 5 May 2010).
The point can be extended to the macroeconomic level. Inadequate domestic savings for private sector investment activity could lead to a growing gap between savings and investments. We are already seeing signs of this in terms of the widening current account deficit, which is larger than what India needs at a time of global economic volatility. The surest way for more domestic savings to be released for the private sector is a sharp drop in the government revenue deficit. That is still at best an unfinished task.
The second big transition that I mentioned earlier is structural rather than cyclical. The last fiscal was the first in which the value of factory output was higher than the value of farm output. India was a predominantly agricultural country when it broke free of colonial rule. The role of agriculture in economic output has diminished since then, but the early dreams of an industrial India remain unfulfilled.
The revised estimates for 2009-10 show that the value of output in agriculture, forestry and fishing at constant 2004-05 prices was Rs6,51,901 crore while the corresponding number for manufacturing was Rs7,19,975 crore. This is the first time since data has been available when manufacturing output was higher than output in farming, forestry and fishing. The two numbers were more or less equal in 2008-09, according to the government statistics office’s quick estimates.
The gap will widen in the years ahead, as industrial growth powers ahead of agricultural growth. India still has a small industrial sector compared with China, but it is no longer smaller than the farm sector. The well-known problem with this structural change is that the change in the composition of Indian output is not being matched with a change in the structure of employment. Too many Indians are still stuck in farm jobs. How to ensure that industrial jobs grow in tandem with industrial output is a challenge that the second Manmohan Singh government shows no signs of tackling.
After all, it believes that loan waivers and entitlement programmes will keep winning it elections.
Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at firstname.lastname@example.org