By 2007-08 the economy had grown at over 9 per cent per annum for three consecutive years. The last time the economy had exceeded the 9 per cent mark for growth was in the late 1980s, and that too only in one year.

At that time it was so unexpected, and its continuation (so) unimaginable, that it did not even provide cause for comment. This time though, the repetition of the outcome over three years had given rise to the expectation in some circles that it was only a matter of time before the double-digit growth barrier would be breached. But this was not to be.

In an unexpected reversal we now have a situation in which growth has been trending downwards since 2008-09 to settle at less than 5 per cent in 2012-13. From about the same time inflation may be seen as having shifted gear forward. Since 2008-09 it has mostly been much higher than in the first half of the decade.

So the principal stylised fact of the decade up to 2012-13 is that somewhere in its middle a macroeconomic regime-switch took place.

The combination of very high growth and relatively low inflation was replaced by the combination slower growth and higher inflation. Two leads present themselves here. First, the declining growth rate suggests something systematic at work. Secondly, that the growth-inflation picture of the second half of the decade is a mirror image of what it was in the first presents the possibility of an independent factor having caused the reversal.

It could not have escaped anyone’s attention that the slowing of growth in India had followed closely the onset of the financial crisis originating in the US in 2007-08. However, growth in India has contracted much more than in the rest of the world. This despite India’s share of world trade being lower and the share of exports in its GDP being less than that of China.

Global factors If, following the global financial crisis international investment flows had involved a diversion of funds from India to the rest of the world, this would have slowed growth disproportionately in India.

Though the rate of accretion of FDI to India has slowed, foreign investment flows are far too small in relation to the size of the economy to have been able to make a major difference. In 2007-08 they had amounted to 7.3 per cent of gross domestic capital formation and 2.9 per cent of the gross national product, respectively.

With respect to inflation, on the other hand, we find that it has fallen in all parts of the world, including China, but risen substantially in India. The data suggest that while global factors may well have impacted growth in India, we have reason to believe that domestic factors have been at work too. By comparison, the higher inflation in India must owe largely to factors specific to this country as it has actually declined elsewhere.

Accounting for the change Two factors account for much of the slower growth and higher inflation during the second half of the last decade, namely slowing agricultural growth and declining public investment. It had commenced with two years of near-zero agricultural growth and was generally a period of fluctuating agricultural output. Thus, after a smart recovery midway through, the period ended up with low agricultural growth once again.

To attempt another characterisation, there was only one ‘bad’ year in the first half of the decade compared to three in the second. So, however viewed, the latter half of the decade is distinctly one of lower agricultural growth with the following consequences. First, repeated negative agricultural supply shocks generated inflation.

For households whose income growth does not keep pace with the rising price of food, higher expenditure on food must have crowded out spending on industrial goods. Note that the real price of food has risen by over 20 per cent since 2008-09. Industrial production has declined from 2010-11 and has more or less ground to a halt now. Of course, it is not necessary that all of this decline is related to slower agricultural growth. In fact, this is unlikely, for the slowdown in industrial growth is far too dramatic, suggesting another aspect.

The macroeconomic policy The one element of macroeconomic policy across the decade that is most closely linked to growth is public capital formation. Public capital formation rose sharply up to 2007-08 (once again, a period of unprecedented high growth) , fell sharply the next year and has remained depressed since. On the other hand, while private capital formation has declined from 2009 onwards its fall was not as precipitous as that in the public.

Capital formation in the private sector actually more than revived by 2012-13, when it exceeded its previously attained peak by over 20 per cent, without being able to make a difference to the overall growth rate.

Secondly, the steep decline in capital formation in the public sector in 2008-09 took place even as the fiscal deficit expanded by over 100 per cent. So, at this time, government expenditure could not have been financially constrained in the aggregate. Only further research can establish whether in allowing the deficit to rise significantly the government was primarily motivated by the desire to increase consumption, both its own and of the households via consumption subsidies, as opposed to supporting growth.

Whatever be the case, the steady decline in public capital formation signals that the government may have seriously misjudged the growth dynamics in assuming that growth would continue regardless of the composition of the spending.

Big reduction It is of interest that private capital formation did not fall as steeply as capital formation in the public sector. In fact, in no year did it fall to a level below the lowest one registered during the period of fast growth over 2003-08. So, overall, there is strong evidence to suggest that the public sector may have contributed more to the growth decline than the private sector by reducing its capital formation after 2007-08.

The magnitude of the reduction is brought home by the feature that by 2012-13 public capital formation as share of GDP was less than half its level in 2007-08.

So what would it take to reverse the reversal? With regard to inflation, steady agricultural growth would be necessary. Where this depends on natural factors there are few short-term policy-based fixes available.

However, government could manage food stocks far better and operate procurement-price fixation more judiciously. For a revival of the growth momentum, increasing public capital formation would have to be part of the plan.

Finance Minister Arun Jaitley has spoken of FDI and PPP in his first Budget. Since then he has berated the Reserve Bank of India for the rigidity of its monetary policy stance. Now he should focus on what he can do to bring about a growth upswing.

Excerpted from the Malcolm Adiseshiah Memorial Lecture delivered at Chennai on November 21. The writer is a professor at CDS, Thiruvananthapuram

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