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S. D. Naik

Despite the pervading optimism and positive outlook for 2003-04, the RBI Report highlights the medium-term issues and concerns. The growth rate of the economy envisaged under the Tenth Plan period is beyond reach going by the current economic parameters. Shifts in growth strategy are needed to step up saving and investment rates and to reduce the high fiscal deficits, says S. D. Naik.

THE Reserve Bank of India's latest Annual Report points out that the Indian economy performed reasonably well in 2002-03 in spite of the simultaneous impact of a series of adverse developments such as the border tensions in the early months of the year and the worse drought in 15 years.

The overall agricultural growth registered a massive decline of 17 per cent and the estimated fall of 29 million tonnes in foodgrains production was the largest since Independence. Furthermore, the global economy was characterised by an environment of generalised uncertainty and low growth in the period leading up to the Iraq war. This period also witnessed considerable hardening of international crude prices.

Outlook for 2003-04

The year 2003-04 has begun on a strong positive note. Thanks to higher than normal rainfall and satisfactory spread of South-West Monsoon so far, the agricultural output is expected to post a strong growth this year.

Industrial growth, which staged a recovery in 2002-03, has maintained its momentum this fiscal, with manufacturing output rising steadily in the first quarter and a turnaround in the consumer durables sector after 12 successive months of decline.

The services sector is also expected to maintain a strong growth. Not surprisingly, the RBI is distinctly upbeat on the outlook for the economy this fiscal and expects the GDP growth to exceed six per cent.

The inflation rate is expected to remain benign; by early August 2003, the wholesale price inflation fell below four per cent. Based on the current assessment, the inflation rate in 2003-04, on a point-to-point basis, is expected to remain in the 5-5.5 per cent range. Consequently, the soft interest rate bias is expected to continue.

This year, business confidence has improved in all sectors against the backdrop of a distinct improvement in the financial performance of the corporate sector, slowing down of inventory accumulation, and an expansion of capacity utilisation and order books.

Moreover, the outlook for the industrial sector is expected to be reinforced by the renewal of agricultural activity, continuing strength of export demand and the improvement in the environment for new investments indicated by a surge in the production of capital goods and the non-oil imports, low interest rates and improved all round corporate profitability.

India's external sector also continues to post gain during the current fiscal with merchandise export growth in April-June 2003 adhering to the target growth path set for the year. Foreign exchange reserves have continued to grow and reached a level of $85.4 billion on August 15, 2003 — up by $10 billion over the end-March level on top of a record increase of $21.3 billion in 2002-03.

Recognition of the growing strength of reserves has led to the designation of India as a creditor country by the IMF under its Financial Transaction Plan (FTP)

Medium-term issues and concerns

Despite the pervading optimism and positive outlook for 2003-04, the medium-term issues and concerns that have been highlighted by the RBI cannot be ignored. The RBI Report makes it amply clear that the growth rate of the economy envisaged under the Tenth Plan period is beyond reach going by the current economic parameters.

It stresses the need to combine increased investment with improvement in efficiency for moving on to the higher growth trajectory and calls for shifts in growth strategy to step up saving and investment rates and reduce the high fiscal deficits.

A major area of concern is an unprecedented deterioration in the rate of public sector saving from a high of 2 per cent of GDP in 1991-92 to a dissaving which began in 1998-99 and touched minus 2.5 per cent in 2001-02, posing a constraint on growth.

The RBI attributes the poor performance of public sector saving to a persistent fall in the gross tax-GDP ratio, coupled with the increase in expenditures on salaries and pensions under the Fifth Pay Commission award. The rate of saving of the private corporate sector also decelerated since 1996-97 as a result of declining profitability in the downswing of the business cycle.

While the stagnation in the domestic saving rate is no doubt a matter of concern, a more worrisome development is the deceleration in the investment rate, which essentially reflects the failure of investment demand to absorb even the available resources.

This is evident from the fact that the overall saving-investment balance has turned into a surplus of 0.2 per cent of GDP in 2001-02 for the first time after 1975-78. This is the result of a severe compression in public as well as corporate investment over the past five years.

There have been big shortfalls in public investment during the Ninth Plan period in agriculture, infrastructure and social sectors. The major reason for the huge shortfalls in public investment is the continuous rise in revenue expenditure over the past decade.

At present, revenue expenditure accounts for nearly 85 per cent of Centre's aggregate expenditure and only 15 per cent goes for investment purposes. Further, of the total revenue expenditure, nearly one third is accounted for by interest payments, other major items being defence and subsidies. Subsidies are perhaps one area where considerable scope for reduction exists.

On the expenditure front, the deteriorating State finances have led to the compression of investment in economic and social overheads. An additional factor that has contributed to the States' inability to undertake developmental activities is the increasing pension payments, which rose from less than three per cent of revenue receipts in the early 1980s to about 10 peer cent in 2001-02.

The salary bills of State government employees for all States had already crossed Rs 100,000 crore by 2000 following the implementation of the Fifth Pay Commission award. This has severely limited the ability of States to improve the physical and social infrastructure. Consequently, the composition of expenditure as well as the stock of infrastructure assets has deteriorated. As for private investment, the constraining factor has been the halting recovery of aggregate demand in the economy because of lack of adequate purchasing power. If the purchasing power has to increase, it is imperative that the rate of employment in the economy is increased through higher investment in agriculture and infrastructure sectors and encouraging labour-intensive manufacturing activities.

The employment growth rate in the economy has declined from two per cent per annum during the 1980s and the early part of 1990s to just around 1.1 per cent in the latter part of 1990s. Employment in agriculture has remained virtually unchanged at 190 million people over the last decade despite its declining share in GDP.

The manufacturing sector is passing through a phase of jobless growth. With the growth rate of working age population exceeding the overall population growth rate, the unemployment rate could worsen further if the envisaged economic growth does not give rise to new activities that are appropriately labour intensive.

A key issue that has been highlighted by the RBI in this regard is the need for intensification of reforms in social security, insurance and other conduits of long-term savings as well as the development of markets and instruments to bring about a convergence between the time preference of savers and the risk-return profiles of investors.

At the same time, institutional mechanisms need to be put in place to draw the saving of the unorganised sector into formal channels. At the same time, it stresses the need to arrest the dissaving in the public sector and the pre-emption of private saving by burgeoning public sector revenue deficits so as to mobilise finances for growth.

Recipe for higher GDP growth

The chapter on Assessment and Prospects provides a recipe for achieving the annual growth target of eight per cent envisaged in the Tenth Plan document. The suggested sector-wise strategy can be summed up as under:

For approaching the growth target of the Tenth Plan, it is essential to step up the growth of agricultural sector significantly. Higher agricultural growth will now have to come from a much more diversified agriculture. This will require much greater investment in rural infrastructure such as roads, storage facilities, telecom, power and the like.

Demand-based agricultural production may necessitate moving away from fiscal price supports in a phased manner towards greater exposure to international terms of trade and the development of alternatives such as futures trading which result in better price discovery and risk management.

The industrial sector will have to grow at the rate of 10 per cent per annum. For this, it is vital to expand the orbit of reforms to the difficult areas of land laws, labour market, and bankruptcy and exit procedures. The long-pending repeal of Sick Industrial Companies Act (SICA) and the abolition of BIFR should be expedited.

Serious efforts are needed to bring down drastically the huge time- and cost-overruns in large public sector projects. Priority needs to be accorded to enhancement of investment limits, greater ancillarisation and larger and quicker credit flow to the small-scale industries.

The key to the envisaged industrial expansion is the modernisation and deepening of the physical infrastructure. The composition of expenditure as well as the stock of infrastructure assets has deteriorated with the neglect of cost recovery.

The principal issue is the levy and collection of appropriate user charges on the array of social and economic services which the States provide (water supply, sanitation, sewerage, transportation and medical facilities). User charges need to be indexed to input costs and the process of periodic revision should become automatic.

For pushing up exports, it is necessary to remove the prevailing restrictions, reduce tariffs that raise companies' costs and make it easier for exporters to borrow. The country will also need to look at ways to promote exports in specific industries, target fast growing markets for its goods and push technology exports.

Export promotion policy needs to utilise the natural complementarity of foreign direct investment (FDI) with export activity. Administrative and procedural hurdles are the biggest impediments to larger FDI inflow.

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