Conclusions and policy recommendations R. K. Sinha

Macroeconomic Projections

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Macroeconomic Projections

Most likely scenario

As years roll by, there will be increasing interdependence amongst the nations of the world, and the Indian economy would be increasingly dependent upon and integrated with the world economy and world trade. Any econometric model for forecasting of the macroeconomic scenarios must, therefore, necessarily factor in the services sector and the external factors.

A caveat. While forecasting the macroeconomic indices for the future, the confidence level is highest when the forecasts are for the coming year or two as major changes in the behaviour of labour, energy, technology and bio-technologies are most unlikely to happen. However, when the time horizon expands to 20-25 years, it becomes increasingly difficult to forecast with any degree of certainty as sudden major changes in any of the spheres can cause upheavals in the economy. To quote an example, if Saudi Arabia were to be drawn into a war with the US and its allies, it would dramatically destabilise the oil economy with cataclysmic economic changes across the entire world. The traumatic effect of September 11would, then, be rendered only as an insignificant blip on the screen of the world economic history.

To project for the next 25 years, a longer run behaviour of the Indian economy over the past 50 years has been considered. The average growth rate during this period has been 4.4% pa. The first three decades saw the Hindu rate of growth of 3.6%, while the next two decades witnessed 5.8%. During the period 1993-99, the growth rate was 6.5%. There was a remarkable upsurge in the growth of the services sector (excluding Public Administration and Defence sectors) during the period 1980-2000. Telecom, Finance, Insurance, Real Estate and Banking sectors were the engines of growth during this period. Industry, including mining, manufactures, construction and electricity, contrary to expectations, declined during the post liberalisation era.
The question that begs an answer is: Can we have an accelerated growth so that at least by 2025 we quadruple our per capita income from the present $500 to $2000, to be able to live the life style of the present day middle income economies? The 10th Plan, to achieve this objective, is already speaking of a growth rate of 8-9%. Will it be feasible?

For accelerated growth, either the productivity of labour and capital must be increased or the supply of these factors of production must increase. While it is difficult to measure the productivity of labour at the aggregate level, the capital output ratio is a fair measure of the productivity of capital. In agriculture, the COR increased during the first 3 decades, but showed distinct improvement during the next 20 years. This was the period when agriculture was diversifying to non-traditional activities, away from wheat and rice. If drastic restructuring of agricultural activities were to take place, there could be considerable improvement in the productivity of capital in the agricultural sector. But this would mean increased investments in marketing, bio-technologies, cold storage, etc, and non-traditional diversified agricultural activities. Investments in this sector are unlikely to come by to the extent required, and hence it is unlikely that any significant change would evolve in the productivity of capital in the agriculture sector.

Industry shows a steady increase in the use of capital with almost negligible impact of reforms. To raise the aggregate level of production, therefore, increased investments are required as there is hardly any efficiency in capital use.
There are, however, visible signs of efficiency gains in the services sector. Banking, finance, insurance, telecom, software industry and real estate have shown remarkable productivity gains over the past two decades. Their operations started in almost virgin markets, hence they were capable of registering high growth rates. But soon the markets would stabilise and further growth would mean competitive cost minimisation and improved use of resources, for which the opportunities are limited. They are, therefore, likely to be overtaken by the law of diminishing returns after a decade or so.
The labour market, however, is experiencing serious distortions. The sectors which are showing efficiency gains are the ones that employ less labour, while the labour intensive sectors are not growing at the pace required for the absorption of labour. A daunting task is, thus, on hand, the resolution of which cannot be delayed. It, however, would require carefully planned policy interventions.
The Incremental Capita Output Ratio (ICOR) also shows marginal impact. While there has been some improvement in the services sector, agriculture and industry have only suffered. Is there, therefore, like Singapore and some other countries, any possibility of a large country like ours to prosper merely on the strength of the services sector? It is apparent that due to a severe supply-demand imbalance, it will just not be possible for India to march ahead merely on the strengths of the services sector.
Since the productivity of labour and capital are not likely to improve meaningfully, the alternative of increasing the supply of capital will have to be resorted to for a sustained accelerated growth rate. There must, therefore, be an increase in domestic savings and Foreign Direct Investment must also go up substantially from the present level of $2-3bn per annum.
At comparative levels of per capita income and development, our domestic savings at 23% of GDP is one of the highest in the world. Only China has a higher rate of domestic savings than ours. Unless, therefore, the income rises, the scope for any meaningful increase in the domestic savings rate is rather limited. The dynamic corporate sector has registered a declining savings rate, there is dissavings in the government sector, and the households sector, whose contribution has always been impressive, has been almost stagnant. There is, thus, no possibility of any dramatic change in the rate of domestic savings, perhaps, at best, it could increase only rather slowly.
This brings us to Foreign capital. Foreign portfolio investments have, for the purposes of developing a scenario, been excluded as they are not productive investments and do not have long term commitments to the country’s growth. In fact, their volatility will always be a cause for worry for the managers of foreign exchange, considering the meltdown effect of such capital in the South East Asian countries in 1997-98.
There is always a certain optimality of absorption of foreign capital. There is no visible sign of surge in Indian exports in the medium term making it difficult for export surpluses accretion at a meaningful level. The competitiveness of Indian industry leaves much to be desired. Diversified agricultural activities are internationally competitive, and, hence, possibilities exist. But we would need political will and diplomatic strength and determination to force the EU and the US to lower the non tariff barriers, while we bring about matching investments in the infrastructure and services required for an all round growth of this sector. It is a veritable political challenge. The question is: Will the public sector achieve these objectives? Till 1980s almost two-thirds of the Fiscal deficit was due to capital investments by the public sector. However, there has been a structural change, and now bulk of the fiscal deficit is due to the burgeoning consumption expenditure of the public sector. There has, thus, been a sharp fall in public investment from 8% of GDP earlier to the present 3% of GDP. To complicate matters, private investment is also not forthcoming at the desired pace. The only major private sector investment has been made by Enron, an investment which is mired in controversies.
The logic of the preceding paragraphs leads one to the conclusion, as also determined by the econometric model, that a baseline growth prospect for the future is an average of 5.5% to 6%. In other words, we can expect to grow at the rate of 5.5-6% pa in the years to come till about 2025. If there is no negative effect of any big shock, then this rate of growth is really not bad, considering that very few countries in the world are able to achieve this rate of growth, and that China also, according to some experts, has been growing over the last two decades only at a rate of 6-6.5% only, as against its proclaimed figure of around 9%. The baseline growth rate of an average of 6% translates into a public investment of 4-5% of GDP and a productivity increase of about 1%, which appear to be realistic. For a growth rate of 8% as projected in the 10th Plan, there will have to be productivity increase of about 3% in capital use and a stepping up of public investment to 5%+, a scenario which is unlikely to be achieved. If, however, bottlenecks appear, then the growth rate could dip to 4.5-5%. The best possible scenario could be a growth rate of 7% if the reforms are pushed through aggressively and there is utmost coordination between the States and the Centre. Beyond 7% is both daunting and challenging. In the baseline average rate of growth of 6%, agriculture is likely to grow by 2.5-3%, industry by 5.5% and services by 8-9%.

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