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It is human nature to swing from excessive optimism to overpowering pessimism, as participants in the financial markets know only too well. The spectacular boom and bust cycle we have seen in the past decade is at least partly linked to investor psychology, as some behavioural economists have argued.

Have some of these mood swings also seeped into the real economy of output, investment and jobs? Earlier this month, Prime Minister Manmohan Singh said in a speech to the Confederation of Indian Industry that the mood in India is “unduly pessimistic". He also asked Indian business leaders to “avoid getting swamped by a mood of negativism".

Manmohan Singh learned his economics during the high noon of Keynesian economics in the West. Keynes believed that human beings often take decisions based on gut feel rather than calm calculation. “Our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities," he wrote in his 1936 classic, The General Theory of Employment, Interest and Money.

The prime minister tried to convince the audience that the current bout of economic troubles is only temporary, and that India will get back to its high-growth path in the coming years. In other words, the Indian economy has not permanently lost momentum; it has only hit a temporary speed bump. Such optimism is in stark contrast to the mood in corporate board rooms, trading rooms and the bazaars, where a noxious combination of falling growth and rising inflation over the past few years have undermined confidence.

India has finished the fiscal year ended March 2013 with the worst set of economic indicators since the crisis year of 1991: low growth, high inflation and a record current account deficit. Even the bottom of the previous economic cycle in fiscal 2003 was better, because anaemic growth was balanced by low inflation and a current account surplus.

It is useful to take a very long view of Indian economic growth to assess whether the current situation can be described as a new normal. I have taken a simple average of the growth rate since fiscal year 1981, which is the point when most economists agree there was a structural break in the trajectory of the Indian economy. This was the year when growth moved to a higher plane after more than a year of near-stagnation in the 1970s.

The intervening 33 years have seen several cycles: good years, drought years, crisis years. Yet, the average growth in the Indian economy since fiscal 1981 is 6.24%, or about 1.24 percentage points more than what India is expected to grow at in the fiscal year gone by. So unless it can be shown that the Indian economy is now structurally weaker than it has ever been in the past three decades, there is no reason to believe that it will grow in the coming years at less than the average since 1981. It is highly unlikely that 5% growth is the new normal.

The trickier task is to estimate what rate the economy can grow at over the next 10 years, especially since many of the structural drivers of high growth have either suffered because of benign neglect or have been undermined by years of misguided policy by the two governments headed by Manmohan Singh under the overall political direction of Congress president Sonia Gandhi.

The secular rise in savings and investment rates after 2003 has reversed in recent years essentially because of fiscal profligacy. The demographic bulge has not been nurtured because of a broken education system. Entrepreneurial talent has been constricted by policies that have muddied the business climate. The great surge in productivity, which came in the wake of the 1991 reforms as well as technological modernization and corporate restructuring in the decade that followed, has also ended. In his recent speech, Manmohan Singh said that the Indian economy has the potential to grow at an average 8% a year. Private sector economists are less optimistic, with many of them estimating the potential growth rate at around one percentage point lower. Amid these debates, one thing is certain: India cannot go back to its pre-crisis growth trajectory unless the fiscal deficit is brought down, corporate investment revives and there are concerted policy reforms.

In a recent paper published in the Economic and Political Weekly, Pranjul Bhandari, an economist with the Planning Commission, has tried to explain the reason behind the 8.2% growth target assumed for the 12th Five-Year Plan. Bhandari has used a simple production function to statistically estimate what rate the economy can grow in the five years to 2017, using measures of fixed capital, labour employment, labour quality and productivity.

The conclusion is important: “Policies which caused the growth spurt of the mid-2000s may already have had (their) impact and the global situation will also not be as benign over the next few years. Therefore innovative thinking, greater efforts and new policies which can be implemented in a time-bound manner will be needed to augment each determinant of growth in order to achieve the Twelfth Plan target over the next five years."

In the draft 12th Five-Year Plan made public in December, the Planning Commission outlined three growth scenarios. The first assumes the government takes the recommended policy steps to reverse the current growth slowdown to grow at an average of 8.2% between 2012 and 2017. The second scenario assumes half-hearted action, when policies are endorsed but not acted upon, to yield a growth rate of between 6% and 6.5%. The third scenario is of a policy logjam. Growth would then drift down to between 5% and 5.5%. In other words, the key to a higher growth rate is in better policy in New Delhi.

Returning to the issue of undue pessimism raised by the prime minister this month, the return of animal spirits may provide a modest boost to the Indian economy but the main burden of reviving growth rests with his government, which may have to telescope into a few months what it has not done since 2004.

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