The Hindu Business Line : The critical policy fixes

It is fitting that the Indian Institute of Economic Growth should celebrate its 50th anniversary at a crucial period in the economy. The current year is not just memorable because it marks the last year of the UPA government; it is important because the consistent run of good fortune since 2003-04 may be most sorely tested. Call it the peaking of a business cycle, or just bad luck to be caught in the slipstream of financial turbulence that threatens western economies, but the trends speak for themselves: industrial output is declining over two quarters, the equity market has been shaky since January and business confidence, according to Reserve Bank of India estimates, has been ebbing since the third quarter. Evidence suggests the economy might be running up against critical supply constraints; power, roads, education. On the positive side, savings and investments are robust. Yet growth forecasts are getting more modest by the day. So what’s missing?

The RBI Deputy Governor, Dr Rakesh Mohan’s keynote address at the Institute early this month contains some clues. He suggested there has been a growth continuum since Independence, with acceleration occurring in periods of reform, namely, the mid-1980s and post-1990. But the character of growth in the five years to 2002 and after was qualitatively different on two counts; a consistent decline in agriculture, dipping to an average 0.9 per cent between 1997-2002, was more than compensated by the dramatic increase in services, so much so, that by 2003-04 — clearly, the watershed year when all indicators peaked — it had overtaken manufacturing to become the main driver of the sustained peak performance. The data also indicate a consistent rise in savings and investment but the tipping point comes in late 2000, after which investment growth accelerates rapidly. Dr Mohan stresses that growth has been financed primarily by domestic savings; but the sharp upturns could not have come without some push from policy, and that is where a consistent release of liquidity through reductions in reserve requirements plus easy interest rates helped turn savings into productive capital at a more rapid pace. Within the overall frame of policy changes, monetary instruments worked well. For instance, the telecom reforms initiated in the late 1990s launched the services sector blitzkrieg in global markets, fuelling, in turn, unparalleled consumption demand.

That demand is now running out of steam. Enhanced domestic savings/investments can reverse the trend, but as Dr Mohan points out, bank credit has to grow. He cautions against excessive money supply but the 6.68 per cent inflation rate is a result of food shortages and, therefore, requires critical policy fixes, not overcautious monetary interventions.

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