The Hindu Business Line : The ever-elusive 8 per cent growth rate

THAT higher growth is essential to improve the quality of life of the people is no more a topic for debate. How best to accomplish it is, of course, an issue. And why incremental growth is not translating to a commensurate fall in intensity of misery of the `have-nots' is another.

For economic growth to trickle down, the rate needs to be sustained in a higher orbit. For an economy of India's size and diversity, the minimum average speed for a decade could be 8 per cent. This may not only allow `trickle down', but also help dispel public apprehension on reversibility.

But what has been the country's progress in this regard? While there were two years of 8 per cent-plus growth rates — backed by unexpectedly high performance in agriculture — for three consecutive years the average was quite near this magic figure.

The formidable East Asian record of socio-economic achievement is reflected in an average annual growth rate in real per capita gross domestic product (GDP) of about 4.75 per cent since 1960. The real per capita GDP growth has been even faster in China and Korea, at about 5.5 per cent over the same period. In India, it is much lower.

With such a dismal record, expecting growth to trickle down is premature. It is akin to "trying to make omelettes without breaking eggs".

There are also a few serious structural impediments in the Indian case.

Usually, sectoral transformation, in terms of contribution to GDP, is in the order of agriculture, manufacturing and services. But in India, the shift in the share of agriculture from half to a quarter went straight in favour of the services sector (half now), leaving manufacturing at the same level, at about a quarter. The manufacturing base remaining weak is increasinglymanifest in choked growth due to inadequate infrastructure.

The caste system, the rigid consumption pattern and the saving habit, that too with strong regional bias, could be the other structural bottlenecks. As a result of the caste system, manpower productivity has not been allowed to contribute to the growth process to the fullest extent.

A chunk of manpower is compelled to marginal productivity of either zero or negative. The extent of initial asset and income inequality not only influences the sensitivity of poverty to growth, but may lead to gender or ethnic discrimination or other inequality traps that keep certain groups of poor households from participating in growth.

Land reform and rigidities in tilling rights have taken a back seat in terms of policy response. While the tiller rarely owns land, the owner rarely knows how to till. This has resulted in massive under-utilisation of land and water resources. In this also there is the influence of the caste system, so much so that growth is snail paced, despite free land and idle hand.

There are a few silver linings though. The negative expectations on inflation and growth and interest rates is getting diluted. The Hindu rate of growth has been redefined at over five per cent. The inflation rate has maintained a safe distance from double digits. Interest rates have remained within an acceptable range.Huge fiscal deficit, massive forex inflows, oil price hike and so on have had not evoked much reaction from the public. Reasonably strong "market economy fundamentals" in the form of sound financial entities, robust regulatory systems and not-too-complicated business practices, have lent India resilience, even as it rapidly integrated with the world economy.

There are institutional frameworks to ensure market discipline. Sufficient checks and balances on equity markets, banks, and external borrowings limit investment bubbles. Immunity to the Asian flu is justification enough for this.

What could be the possible routes to achieve an average 8 per cent sustainable growth rate?

With the incremental capital output ratio (ICOR) at 4, an average 8 per cent growth rate would require an average level of savings ratio of 32 per cent. Because of the continued trend of dis-saving by the government sector, despite good savings by the household sector, the savings ratio appears to have plateaued at around 23 per cent. Since incentivising households to save more may boomerang by way of reduced spending and hence constrained demand for production of goods, which would not allow growth rate to be sustained, recourse to foreign savings has become necessary. And rightly so, given the benefits to be reaped by opening up in a global economy. Reforms in the government sector could supplement this in a big way.

The major plus of the East Asian success story was the undivided attention paid to infrastructure development to aid exporters and import-competing firms.

Pricing as a tool to boost exports is transitory. Saleability, deliverability and better economy of scale are the real issues. Greater diversification in terms of geographical reach and products is needed to sustain the current boom in exports.

The slowdown in exports experienced in the Asean (Association of South-East Asian Nations) region in 2001-02 on account of over-specialisation in information technology products as the main export item, and the reliance on the US as the primary export market should remain a ready reminder.

India continues to have a revealed comparative advantage (the ratio of the share of the commodity in the country's exports and the share of the commodity in total world exports being greater than one) in very few exportable commodities. The correlation between the rate of internal structural transformation (the ratio of the percentage change in the share of non-agricultural value added in GDP and rate of growth in GDP) and rate of growth in exports is quite small. This corroborates the lack of commensurate improvement in the non-agricultural sector, especially in infrastructure/transport sector, the growth in which is another necessity for exports to expand.

Notwithstanding its famous outsourcing industry, India continues to remain, in the real sense, a relatively closed economy; exports of goods and services represent about 15 per cent of GDP and account for less than one per cent of the world's merchandise exports. Intra-Asian trade is waiting for an Indian take off.

India should learn to exploit the increasing international demand for relocation of labour-intensive assembly operations as it is has all the ingredients to compete with China to be an international manufacturing hub. India has the added advantage of being able to project itself as an outsourcing hub for knowledge-based activities as well.

Studies have shown that a three per cent incremental growth in agriculture will lead to 2.6 per cent growth in manufacturing, which will then lead to 8 per cent growth rate. Going by the perceived trend of agriculture-induced growth in India, the focus has to be brought back to this sector by creating massive rural infrastructure.

Projects such as river-linking, minor irrigation and rural water supply can generate enough purchasing power and confidence in agricultural producers/workers to reconsider the sector as an avenue for livelihood. Given the rural thrust of banks, loans for genuine proposals in this area may not be a problem. India must reduce its vulnerability to the monsoon shocks to maintain growth and distribution.

A lower interest rate regime helps maintain growth at a higher trajectory while ensuring a better quality of life for all. Each one per cent decline in real interest rate adds about 0.35 per cent to growth rate. A 4-5 per cent decline in corporate borrowing costs boosts the growth rate by about 1.5 per cent.

Reduced nominal interest rate for production (lending rates), given a benign inflation climate, would reduce production costs, leading to higher investment and lower prices, and which then reinforce each other towards sustained growth. But the problem here is that to allow financial entities a reasonable spread to sustain their existence, deposit rates have got to be reduced as a necessary policy response.

This has the potential for social discontent as it makes the household savers poorer by the amount of reduced interest income. This loss needs to be compensated through reduced household expenditure brought about by a general decline in prices. The sooner this equilibrium is reached the better.

But the pangs of transition will be there. While the income loss is instant, gains by way of reduced prices come with a time lag. Once the end of the lag is reached, the economy will start remaining on a higher growth orbit without any perceptible pauperisation.

Further, it would also mean lowering the government's interest burden thus releasing more funds for productive investments. Studies have shown that such reduction by 1.5 per cent of GDP would mean an addition of about 0.5 per cent to growth rate. But this presupposes that the government will use the funds so released in avenues that offer positive returns either in the short- or long-term.

Demographic dividend by way of surplus productive manpower may not sufficiently accrue, unless the available manpower is healthy and educated. This requires immediate focus on expenditure on health, education and other social indicators.

Empowerment of woman has become an economic variable catalysing both quantity and quality of the growth process. The right initiatives now will make them employable in the growth process of the future. India then maybe able to pitch for the `economic superpower' title.

There is a flip side to this optimism. An aging population led growth slow down in advanced economies could mean weaker demand for exports from developing economies such as India. It may also slow the flow of capital to support investments in India. Studies have suggested that such adverse demographic shocks elsewhere may dampen per capita income growth of emerging Asian economies by 0.25 point per year over the 2020-2050 period.

To meet such eventualities, policies to boost employable labour supply, savings or productivity need to be initiated now. The projected decline in the working-age population in the developed economies may required to be met by encouraging more immigration from developing economies.

Hence, the challenge for India would be to ensure that surplus working-age population is adequately trained to be absorbed into the labour force, both domestic and international.

Corruption and good governance are not socio-political issues anymore. They have economic implications as well. Studies have shown that a unit hike in corruption lowers foreign direct investment by 11 per cent and the revenue-GDP ratio by 1.5 per cent, thus lowering GDP growth by 1.4 per cent.

Unless corruption is tackled resolutely through good governance it will have significant economic costs that will impede sustained growth rate prospects. An action plan needs to be evolved to address poor rule of law, weak institutions, and lack of transparency so that a sound investment climate is created. Corruption not only puts off international investors, it also shakes the confidence of domestic investors.

A recent World Bank study, Pro-poor growth in the 1990s: Lessons and Insights from 14 Countries, underscores the importance of promoting strong and sustained growth as part of any pro-poor growth strategy.

What needs to be addressed is: How to accelerate growth in ways that reduce poverty. The best way to accomplish this in a developing economy such as India is to design projects dealing with infrastructure and rural development so as to make the poor benefit directly.

Policy options to help poor households take advantage of non-agricultural and urban employment opportunities need to be emphasised. This could include improving the investment climate; expanding access to secondary education given the rising skill premium that tended to accompany strong non-agricultural growth in the 1990s; enhancing access to all levels of education to girls; designing labour market regulations to create more formal employment for poor workers, and improving access to infrastructure, particularly roads and electricity, to better link rural areas to small towns and urban centres.

(The author is a General Manager of the Reserve Bank of India and teaching at its Officers Training College, Chennai. The views are personal.)

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