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The Rediff Business Special / Dr C Rangarajan

The Indian Economy: What Lies Ahead?

Outgoing Reserve Bank of India Governor Dr C Rangarajan's forecast for the Indian economy

The decade of the '90s has seen India rapidly transforming into a high-growth economy. There has been an enormous change in the economic environment since 1991, with the introduction of reforms as part of a comprehensive stabilisation and structural adjustment programme.

The basic objectives of the current reform programme have been to remove various structural constraints in market activities and to let competitive forces improve efficiency and productivity in the economy. Structural reforms in industrial and financial policies and trade regime have been combined with fiscal and monetary policy reforms to ensure macro-economic stability and also to enhance long-term growth prospects.

Performance Indicators in 1996-97

During the past three years, the economy has done well in several spheres. While the growth conditions have improved significantly after the initial downturn in the early phases of stabilisation, this achievement has been marked by two qualitative developments. First, the growth rate in real GDP (gross domestic product) exceeded seven per cent successively for two years, in 1994-95 and 1995-96. In view of the higher growth of 5.7 per cent estimated for agriculture and other allied activities, the rate of growth of real GDP is placed at 6.8 per cent in 1996-97.

The trend over the last three years has brought about a significant shift in the perception relating to the long-term growth prospects of the economy. This has created a major impact on the long-term investment opportunities in the economy. Secondly, unlike the decade of 1980s, the achievement in the growth front in recent years has come about with notable improvements in some of the macro-economic parameters in the economy. This has been reflected in a higher saving rate, a lower order of fiscal deficit, a sustainable external payments situation and a relatively stable exchange rate environment.

Industrial growth, after showing a speedy recovery in 1994-95, touched a high of 12.1 per cent in 1995-96. Industrial growth however, decelerated during 1996-97: the overall industrial production index grew by 6.8 per cent. A major deceleration was noticed in the 'mining' and quarrying' and 'electricity' sectors. Mining and quarrying activity increased by 0.9 per cent during 1996-97, well below the 7.4 per cent level attained during the previous year.

The rate of growth of electricity generation has come down to 3.8 per cent as against 8.1 per cent in 1995-96. It is somewhat puzzling how a growth rate of 3.8 per cent in electricity has been able to support a manufacturing growth rate of 8.2 per cent. The manufacturing sector, after doing well in the first nine months of 1996-97, decelerated thereafter. But, comparatively, the deceleration in the manufacturing growth (8.2 per cent during 1996-97 as against 13.6 per cent in 1995-96) was less pronounced than that of the infrastructure sectors.

From the user side of industrial, production, consumer goods sector decelerated significantly to 3.1 per cent in 1996-97 as compared with the growth of 14.3 per cent during 1995-96. What has accounted for this slowdown is the sharp contraction in the growth of the consumer durables to 4.7 per cent as against 36.1 per cent in 1995-96 and a somewhat lower order of growth of 2.6 per cent in consumer non-durables than 8.8 per cent in the previous year.

Both the basic goods and intermediate goods sector grew at a slower pace, of 8.2 per cent and 8.3 per cent respectively in 1996-97; in the preceding year, these sectors recorded output increases respectively of 8.3 per cent and 11.8 per cent. Compared to the performance of these sectors, the capital goods sector did better by posting a growth of 8.4 per cent, but it was sharply low in relation to the 17.9 per cent growth recorded in the previous year. The declaration in the capital goods sector has also coincided with the decline in the capital goods imports by 10.9 per cent 1996-97 in contrast to 35.3 per cent growth seen in 1995-96.

The deceleration in industrial growth in 1996-97 has caused considerable concern. This deceleration can be analysed in terms of supply and demand factors. While undoubtedly over the medium term infrastructure constraints can act as a brake on growth, there is no reason to believe that supply constraints were more severe in 1996-97 than in 1995-96.

We, therefore, need to find an explanation from the demand side. On the demand side, the rural consumer demand in 1996-97 must have been weakened by the negative growth in agriculture in the previous year and the consequent decline in rural incomes.

The demand for consumer durables follows a cyclical pattern with high growth being followed by deceleration. The consumer durable goods industry rose sharply for three consecutive years with an average growth rate of 21 per cent. The deceleration in 1996-97, in that sense, is explained by the very sharp increase in the previous years. Export growth was sluggish in 1996-97. Besides domestic factors, a major contributing factor must have been the decline in world trade, which grew only by 5.4 per cent in 1996 as compared with 9.7 per cent in 1995.

While overall government expenditure maintained the usual growth rate, there is evidence to indicate that the growth rate is public investment decelerated in 1996-97. As for private investment demand, the continued sluggishness noticed in the primary capital market must have moderated private investment expenditure. Some of these factors are however self-reversing in character.

The trends in industrial production in the current year have not shown much improvement over the last year. In April, the overall industrial production grew by 7.5 per cent. However, in May and June of the current year, the growth rates have been much lower than in the previous year. While the mining and electricity sectors have done better, the manufacturing sector has, however, shown a steep decline in growth as compared with the previous year.

Thus, the first quarter growth rate in the current year at 5.2 per cent is much lower than 11.8 per cent in the first quarter of 1996-97. However, some data available for July and August indicate a pickup in the infrastructure sector. For the period April-August, six infrastructure industries, having a total weight of 28.8 per cent in the index of industrial production, showed a rise of 4.5 per cent in the current year as compared with an increase of 3.6 per cent in the previous year.

The production performance of 24 industries, with a weight of 50.37 per cent in the index of industrial production, showed an overall rise of 8.3 per cent in July 1997 as compared with an increase of 4.6 per cent in July 1996. For the period April-July 1997 these industries show a rise of 6.5 per cent as compared with a rise of 5.4 per cent in the previous year.

Agricultural growth, unlike industry, showed a smart recovery in 1996-97 (5.2 per cent) from the negative rate of growth in 1995-96. The foodgrain production during 1996-97 is estimated at 198.2 million tonnes, which is an all-time peak so far. The foodgrains production has in the process recorded a growth rate of 7.1 per cent during 1996-97, the highest in last five-year period 1992-93 to 1996-97.

An important question which has been raised in the context of the current situation is: How far will the economy be able to maintain a growth rate of seven per cent or more in future and what are the preconditions for achieving this target?

I think the issue has to be addressed both from the resources side and from the angle of the physical structural constraints in the economy.

On the resources side, improvement in the domestic saving rate would constitute the most critical factor for accelerating the growth momentum in the economy. In 1995-96, the domestic saving rate reached a new peak of 25.6 per cent, which with a net inflow of external resources of 1.8 per cent, increased the investment rate to 27.4 per cent.

The estimates relating to the saving rate for 1996-97 are not yet available. However, if the saving rate achieved in 1995-96 is maintained in 1997-98, it is possible to realise an investment rate of around 27 per cent, assuming the current account deficit to be about 1.5 per cent of the GDP. It is also important to note that, with increased competitive pressure, the economy is slowly but gradually moving up on the productivity scale, which is reflected in the recent decline in the incremental capital output ratio.

During the period 1993-94 to 1995-96, the mean ICOR declined to 3.7 from over four in the 1980s. These trends would indicate that achieving a growth rate of about seven per cent in the medium term may not pose a difficult challenge.

But, the key question is: what policy conditions will be required to maintain and perhaps enhance the saving rate of around 27 per cent? Clearly, public sector saving must show further improvement from the level of 1.9 per cent of GDP achieved in 1995-96.

While the household saving responds to a host of factors, including the growth and distribution of income, from the policy point of view, maintaining an appropriate interest rate assumes critical significance. What the appropriate interest rate should be to provide incentive for saving and at the same time encourage investment depends on the relative elasticity of saving and investment to interest rate.

In the light of current developments, a major growth constraints may stem from the slower rate of expansion of infrastructure industries than what would be required to sustain a growth rate in excess of seven per cent or so.

Improving infrastructure position would not only require a large order of investment, both in the public and private sectors, over a medium to longer-time horizon but also effective and efficient utilisation of the existing capacity. The latter consideration becomes relevant in the context of maintaining the growth momentum in the short run.

The monetary and financial developments in the economy during 1996-97 remained fairly satisfactory, highlighted by the containment of the broad money growth (M3) within the target range for the year, a considerable improvement in the price situation as measured by the movement in the wholesale price index for the year as a whole, and a decline in the short-run interest rate.

A slow rate of expansion in the reserve money helped to restrict M3 growth to 15.9 per cent in 1996-97, which was within the target range of 15.5 -16 per cent envisaged for the year. The deceleration in the reserve money growth stemmed from the combined effect of a sharp reduction in the cash reserve ratio in the second half of the year, and a decline in the utilisation of export credit refinance by banks.

The net RBI credit to the government increased by about 2.3 per cent during 1996-97 as against 19.6 per cent in 1995-96. There was, however, a large order of increase (28 per cent) in the net foreign assets of the Reserve Bank during the year.

Despite the strong improvement in the lendable resources, following a large order of release of liquidity through reduction in cash reserve requirement, the credit demand remained sluggish, with the non-food bank credit showing a growth of 10.9 per cent in 1996-97, as against 22.5 per cent in 1995-96.

This has happened despite the decline in the prime lending rate of most of the banks. The capital market developments show that resource mobilisation through primary issues came down from Rs 229.29 billion in 1995-96 to Rs 188.54 billion in 1996-97. The depressed capital market has also played its role in the deceleration of bank credit to commercial sector, in as much as there has been to be a balance between debt and equity.

The inflation rate, as measured by the increase in the wholesale price index (on an average basis) declined from 10.9 per cent in 1994-95 to 7.8 per cent in 1995-96 and further to 6.4 per cent in 1996-97. In an effort to sustain this improvement, monetary policy has continued to lay stress on modulating the monetary growth that would be consistent with the expected growth rate in real GDP and a target rate of inflation during the year.

During 1996-97, the monetary policy had envisaged containment of the price rise to around six per cent. The actual inflation rate has stayed around that level.

The external payment situation in the country has eased considerably since the crisis of 1991. Merchandise exports in US dollar terms maintained an average growth of about 20 per cent during 1993-94 to 1995-96. In 1996-97, according to the provisional trade statistics, exports are estimated to have risen by 4.1 per cent. The slowdown in the export growth (in US dollars) can be attributed to a declaration in the export growth rates of both primary products and manufactured goods.

The deceleration in export growth in part reflects a major slowdown in the world exports in 1996. For the developing countries as a whole, exports grew by only six per cent in 1996 as against 11.7 per cent in 1995, while for the advanced countries, export growth fell from 8.8 per cent to 5.1 per cent during the same period.

The trends in the important growth in terms of US dollar has also revealed a sharp deceleration in 1996-97, from 28.0 per cent in 1995-96 to 5.1 per cent in 1996-97, largely led by a 2.3 per cent decline in non-oil imports, as against a large increase of 33.8 per cent in 1995-96. The overall current account deficit is expected to be around a little over one per cent of the GDP. The order of current account deficit seen in recent years is very much sustainable.

The overall trend in the external payment situation in 1996-97, as revealed by the sizeable build-up of foreign currency assets of the Reserve Bank, remains comfortable. The stock of foreign currency assets has grown from $ 17 billion at the end of March 1996 to $ 22.4 billion at the end of March 1997.

The exchange rate of the rupee remained stable during 1996-97. With the increasing integration of the exchange and money markets in India, the focus of monetary policy has been on maintaining proper co-ordination between these two markets on a day-to-day basis for ensuring the objectives of inflation control and a competitive real exchange rate. Almost all the external sustainability indicators have remained very favourable.

Current receipts as a ratio of current payments is expected to be at 93.1 per cent in 1996-97 while the debt-service ratio is estimated at 25.4 per cent.

Dr C Rangarajan, continued