Beyond the Global Slowdown

By Pulapre Balakrishnan


Since 2008-09 the rate of growth of the Indian economy has slowed. As this has followed quite closely the evolution of the global financial crisis, and coincides with the slowing of the world economy, it has encouraged the belief that India’s woes are explained away by reference to the global trend. This is unfounded. Firstly, following quite a sharp decline in 2008-09 the economy made a smart recovery and in the two succeeding years grown at rates over 8 percent per annum. This suggests that the slowing of the world economy had only a temporary impact on the domestic one. Moreover, according to the IMF’s World Economic Outlook released in January, the world economy grew by 5 percent in 2010. This is one of the highest rates of growth registered in recent years, and compares favourably with the levels registered in the period immediately before the crisis. A summary quantitative measure of the role of the external sector in driving demand would be the contribution to GDP expansion of net exports. For the year 2009-10 this turned out to be only minus 8 percent. Interestingly, the corresponding figure for the year 2005-06, a year of close to 10 percent growth was at minus 18.6 percent far greater.  We may also note that over the period April-January in the current financial year the growth of exports exceeded 23 percent compared to 10 percent for the same period in the previous financial year. Thus it would be difficult to attribute the slowing of the Indian economy over the past two years, in particular in the year drawing to a close, to factors external to it.

            It is not difficult to track down the principal causes of the current slowing of India’s economy. Actually, we need look no further than the performance of agriculture and the record of public investment in recent years. Following rapid growth in 2007-08, agricultural production declined for two years consecutively since. It may have recovered in 2011-12, but the impact of a supply shock is likely to be spread out over time. Also, its influence  is felt in ways other than via the easily understood supply and demand linkages that the agricultural sector has with the rest of the economy, a point to which I shall return. When it comes to understanding the slowing growth impulse, after agriculture, there is public investment to be considered. Gross fixed capital formation as a share of economy-wide GDP has remained more or less constant since 2007-08. This is in sharp contrast to the record of public investment during the five years of very high growth over 2003-08. During this period public capital formation grew faster than in any five-year interval since the 1950s. This suggests a relatively unsung role for the public sector during the high-growth phase that was the tenure of UPA I. Studying more closely the history of this phase suggests that declining public investment has something to do with the subsequent slowing.


            The role of public capital formation in the future of the economy deserves far greater attention than it has received. Since 1991 the whole approach to the question has got mired in the zeal that has accompanied the argument for reforms, construing it as merely liberalisation of the economy. However, it can hardly be anyone’s case that we have enough of roads and sidewalks or electricity generating capacity or even pucca school buildings. There is reason to believe that for the foreseeable future these will largely have to be provided by the public sector. However, there is the crucial question of how this is to be financed when the government is debt-strapped. I shall turn to this after considering the indirect impact on growth of the two years of stagnant agriculture alluded to.


            The direct impact of agricultural growth feeds through to the rest of the economy via supply and demand linkages. Then there are the roundabout effects that can be as powerful. When the growth of food production falls short of the growth in demand for it, the relative price of food increases and inflation results. We have experienced such inflation for close to 2 years now. Such inflation gets generalised across the economy via rising wages in the rest of the economy. In due course, it can lead to a depreciation of the exchange rate which raises the cost of imported goods, including that of oil. This raises the cost of transportation, contributing to a further rise in the price of food. With this the cycle of price rise is renewed. Now growth in the non-agricultural sector slows. This follows directly from the fact that the necessarily rising expenditure on food crowds out expenditure on other goods and services of the fixed-income households. The slowing of non-agricultural growth can ameliorate inflation as it chokes off the demand for food. This is the precise sequence of events that we have witnessed over the past two years, with manufacturing output growth almost grinding to a halt in the last quarter.


            Our diagnosis of the causes underlying the slowing of the Indian economy brings along with it the obvious solutions. As I have emphasized agriculture and public investment I shall stick with these. This does not mean that other factors are irrelevant, only that I am being faithful to the parsimony of my explanation of recent growth. When dealing with an agricultural shortfall we need to first acknowledge that there are no short cuts, and that the project of making a dent is a long-term one. Public policy towards agriculture would have to address two issues. First, at 7.7 percent of the total gross capital formation appears far too low for a sector already groaning under inadequate infrastructure.  And though we would be right to expect private investment to increase, public capital formation often acts as a catalyst to the former. This is so as the public sector alone provides the public goods essential for sustained growth. However, even as we consider the bearing on growth of increasing public capital formation, it is important to face up to the finding of a rising incremental capital-output ratio in agriculture. Apparently waste thrives despite the rhetoric of the reforms. Evidently, it is one thing to build rural roads and irrigation networks but it is an altogether different matter to get them to work efficiently. The inescapable inference is that governance is central to growth. In fact, the future of economic growth in India is going to be determined by the quality of public intervention. For all the sound and the fury that it may be expected to generate, the forthcoming union budget can do very little in this regard.


            However, there is a sense in which future budgets will continue to matter. We have already referred to the importance of sustained capital formation. It has been flagged for some time now that public capital formation by the central government is being crowded out by producer and consumer subsidies. Among the former are the fertiliser subsidy and among the latter is food and fuel. Even before curbing the deficit, fiscal correction ought to take the form of maintaining or even increasing the food subsidy where it is merited while gradually eliminating all others. The funds thus freed up may be directed towards capital expenditure. The fact is that India has not yet completed its agricultural transformation, the hallmark of which is that food is made cheaper and expands the market for other goods. Note that producer subsidies in agriculture have not made any difference here. Actually, they may have held up the necessary transformation.


            The slowing of the world economy does not imply that India should give up on leveraging global demand to move its economy forward. Opportunities continue to exist, as seen from the reported growth by 33 percent so far in 2011-12 of a relative newcomer among India’s IT firms. But at the same time, the writing on the wall is that India can no longer afford to ignore domestic demand. To respond smartly to this imperative would require a change in the mindset of its polisariat. So far its approach appears to have been to focus on a limited aspect of the supply-side, namely, the incentives faced by producers. But by now it is emerging that if we want to grow at rates that we have got used to we must broadbase and grow the internal market.