The Hindu Business Line : Can India sustain over 8% growth?

Inflation and the measures to tackle it may impact spending on social and physical infrastructure, in turn, making difficult the sustaining of an 8 per cent-plus growth rate, says ALOK RAY.

In the Budget session of Parliament, the first task before the Finance Minister, Mr P. Chidambaram, is to present the Economic Survey, the official version of the state of the economy. As in any government document, the trick is to highlight the bright spots as the achievements of the present government while passing the blame for the not-so-rosy features to the policies of the earlier governments or to external developments beyond the control of the administration. So, instead of waiting for the government version, a look at the state of the economy on the eve of Budget 2007.

According to the advance estimates of national income released by the NSSO, GDP for 2006-07 is expected to grow by 9.2 per cent — the highest in 18 years. It also comes on top of a 9 per cent growth in 2005-06. Hence, critics cannot dismiss it as the base effect of low-growth previous year.

Only once did the country have double-digit growth — in 1988-89, GDP grew at 10.5 per cent. But that double-digit growth was propped up mainly by a 15.5 per cent growth in agriculture, which was clearly unsustainable.

By contrast, in 2006-07, agriculture is estimated to grow at only 2.7 per cent. Growth is being primarily fuelled by industry and services.

Windfall gains

The Finance Minister is deriving a windfall gain from the consecutive years of high GDP growth. Growth leads to a rise in tax revenues but government expenditure does not go up automatically. Thus, fiscal deficit shrinks. Further, the higher level of GDP reduces the deficit-to-GDP ratio, the usual yardstick to judge a Finance Minister's performance. Two other pieces of data also point to a healthier macro-economy. The savings rate is expected to reach 35 per cent of the national income. This implies that the economy can now maintain its growth momentum even without the help of foreign savings. In addition, the foreign direct investment (FDI) flow is expected to exceed $10 billion for 2006-07. These are not fickle foreign funds. FDI means more factories, production and jobs.

But the party may be spoilt by the inflation numbers. Inflation, as measured by the Wholesale Price Index (WPI), has touched 6.73 per cent for the week ending February 2. A year ago, it was 3.98 per cent. Evidently, rising inflation is the No 1 worry for the government. With elections round the corner in some major States, the gloomy inflation figure could become a political issue.

No doubt, inflation hurts hardest the poorest and those earning fixed incomes; incidentally, this segment forms the largest set of voters. The amount/quality of goods fixed income can buy falls. Their already low standard of living is squeezed further.

Supply-side presure

Inflation is a process of rising prices caused by demand-supply mismatch. The broad consensus among economists is that the current rise in the inflation rate is driven primarily by supply-side factors. Of the WPI components, the highest rise in prices has been of agricultural commodities.

Of these, over the last year, the prices of pulses rose 28 per cent, cereals 10 per cent and oilseeds 27 per cent. The root cause is an absolute fall in the production of pulses and the stagnant output of cereals and oilseeds in 2004-05 and 2005-06 (estimate) as compared to 2003-04 even as the demand for them has been rising steadily as result of growing incomes.

It must be remembered that the inflation rate in fuel prices has been falling recently. Had crude oil prices been going up at the same rate as before, the WPI may have crossed 7.5 per cent. Further, CPI (Consumer Price Index), which is a better measure of the inflation on the average standard of living, usually rules above the WPI when the inflation rate is rising.

The Reserve Bank of India is uneasy over bank credit and money supply for the current year growing much above the target rates. This is mainly due to the automatic rise in the money supply, as the RBI is continuously adding to its foreign exchange reserves by buying forex from the market with rupees.

The consequent rise in `base money' is enabling banks to lend more, especially for housing. Easy liquidity may have contributed to the boom in the stock market, real-estate and even the consumer durables segment. But this has no significant effect on the core inflation rate which concerns the poorer sections more.

Nonetheless, the RBI has raised the CRR by 50 basis points to siphon out Rs 14,000 crore from the banking system. This is on top of its hiking the overnight lending (repo) rate by 25 basis points. One wonders whether putting the brakes on money supply growth and raising the interest rates are more likely to dampen the GDP growth rate than the inflation rate.

Impact of futures trading

Apart from the monetary tightening, the Government has initiated some steps to contain inflation. It has cut import duties on edible oil, metals and cement. It has allowed zero duty import of wheat and pulses, along with banning export of these commodities and futures trading of urad dal and toor dal whose prices have gone up by 40 per cent and 9 per cent, respectively, over the last year. Economists, however, are not sure of the impact of futures trading on the price trend of commodities.

For example, the price of moong dal has risen by 36 per cent over the same period but it was not at all traded in the futures market. The government has also cut petrol and diesel prices to produce an immediate downward effect on the inflation rate. Fuel has a weightage of 15.4 per cent in the WPI basket.

The Government is reportedly thinking of bringing down the peak Customs duty rate (applicable to non-agricultural products) from 12.5 per cent to 10 per cent or below in the Budget. This should further help reduce the prices of cement, metals and manufactured products which are rapidly becoming costlier.

If the RBI eases on its reserves-building exercise and allows the rupee to appreciate, the rupee prices of imported goods would fall, and through the competition effect, that of competing domestic products. But the problem is that the rupee has already appreciated, in real terms against a basket of major currencies by more than 6 per cent over the last eight months. So, any further appreciation, even if preferred by the Finance Ministry as an inflation-controlling measure, would not be liked by the exporters or the Commerce Ministry.

Improving farm productivity

As longer-term measures, the Government will have to take steps to improve agricultural productivity so that the output of cereals, pulses and oilseeds keeps pace with the growth in demand arising out of an economy growing at over 8 per cent.

Another cause for worry for the Finance Minister is the trend of rising interest rates. The trend will grow stronger as the inflation rate picks up. Higher interest cost on future government borrowing would push up the government's interest outgo. This would leave less to be spent on much-needed physical (power, transport, communication) and social (education, health) infrastructure.

India spends 4 per cent of its GDP on infrastructure. The corresponding figure for China is about 9 per cent. Thus, the already creaking infrastructure will be strained further. This may make it difficult to sustain an 8 per cent-plus growth. China has managed to grow at around 10 per cent per annum over decades while maintaining an average of 2-2.5 per cent inflation rate. Can India emulate its giant neighbour?

(The author is a former Professor of Economics, Indian Institute of Management, Calcutta. His e-mail: alokr@iimcal.ac.in)