It was a good year, with pleasant surprises

The most remarkable thing about 2005 has been how most expectations have materialised and the few odd surprises have overwhelmingly been pleasant ones. Economic growth at home has certainly been much stronger than anyone could have hoped for?from a consensus that would have seen 7% as bordering on the optimistic, to a situation where 7.5% plus seems eminently feasible.

From the world?s perspective, the India growth story has passed from being a possible flash in the pan, to the acceptance that a stable growth in excess of 7% might well be sustained. Global growth also, particularly in the USA and also Japan, has turned out stronger than expected by many. The hard landing feared by some for China has not materialised and that economy seems set to go from strength to strength. Crude petroleum prices failed to get past the $70 per barrel mark that many feared and, indeed, seem to have stabilised in the $55-60 range. High prices do create supply responses and do help curb demand a tad. Domestic inflation has, as widely expected?stayed below 5% and the Reserve Bank?s target for March 2006, at 5-5.5%, is likely to materialise. Global inflation also, notwithstanding the spike in oil prices, has not risen excessively. US policy interest rates, as also those in many other countries, including our own, have continued to be raised through the course of the year, much again as expected.

Like ordinary humans, markets take heart when their expectations?good or bad?turn out to be correct. For, that means their reading of the near-term future is reasonably accurate. Or, in other words, the information about the future available today has predictive value. Which, in turn, means that risks become lower and economic agents react to this changed perception about risk more purposefully. When the opposite happens, and markets are taken by surprise, the risk perception about the future spikes upward and everybody wants to lower their exposure to the future?and that brings down the level of economic activity.

Since 2005 has so nicely fulfilled expectations?in-cluding the numerous rate hikes by the US Fed?and the few surprises have all been positive, the risk perceptions about the near term are possibly lower than what they were a year before. Which explains quite a bit of the enthusiasm evident in the equity markets at home and abroad; incidentally, the total increase in the Indian index since the beginning of 2005, at 42%, was lower than that of Russia (93%) and South Korea (52%), and comparable to South Africa (43%) and the Czech Rep (41%), besides Japan, Denmark, Poland Sweden and Switzerland. As in so many other matters, there is no evidence of Indian exceptionalism!

Exceptionalism has, unfortunately, been much in evidence when we come to creating the physical and social infrastructure necessary to support the process of economic growth and make it more widespread and inclusive. At every turn, we seem to run into the ever-vigilant agency of wilful ignorance and lethargy, vested interests (including unions) and the accumulated burden of bad ideas.

Power sector reform for years was on the wrong track, propelled by the amazing ability of the system to keep it a secret that the pivotal problem in the industry was widespread theft, not inadequate generation capacity. It took a long time to understand that it was not 17.62%, or whatever nonsense, put out by the official book keepers, which was the transmission and distribution loss, but more like 40% or 50%. Only then, over the past few years there has been progress, albeit agonisingly slowly.

The golden qua-drilateral scheme has done better, but it will be a great challenge to create the network of modern roads that can help transform the rural economy. The friendly fire?within the government and the UPA?in which the modernisation of the airports at Delhi and Mumbai has got embroiled, is perhaps an excellent example of how not to do some things. It is a good question to ask, if we want to build a few world-class airports, whether competitive bidding is really the best approach? Or, should we have a negotiated settlement with a short-list of technically qualified vendors? Do we go for competitive bidding when acquiring nuclear aircraft carriers or submarines?

Anyway, something will come out of the muddled way we do things. But it is desirable that something comes out earlier than otherwise, whether third or fourth best, since securing the first-best outcome appears incompatible with the manner in which we choose to draw our priorities and enforce our delayed decisions.

What can we expect in 2006? Much of what will happen in India is going to be decided by how much (or how little) progress we are able to make on infrastructure. But that aside, there is little reason to believe that consumer spending, which has been driving manufacturing growth, will suddenly take a tumble. There is, however, some danger of the shine going off on exports and data for November raises concern. However, unless (and there is no evidence in yet) our exports are turning uncompetitive, significant slowdown in export growth is not likely. On balance, some slowing in light industry is certainly possible?in some cases due to slowing aggregate demand and in other cases due to inadequate infrastructure. But, in mitigation, there might be an increased level of investment?both in manufacturing and in infrastructure. Going forward, domestic conditions appear able to support economic growth at 7% plus. Anything over and above that is contingent on better than average outcomes on an array of fronts.

Globally, with the US rate rise cycle appearing to be at the end of its journey, oil prices seemingly stable and nothing upsetting on the horizon, conditions do look good, even if the slight slowdown in US growth were, indeed, to materialise.

The writer is economic advisor to Icra