The Icrier team was invited this year by the India International Centre to present its Mid Year Review of The Economy. The importance of this Review, as reflected in the attendance, has clearly declined since Dr Malcolm Adeshesiah?s time. Though understandable, this is regrettable simply because there is no substitute for such a discussion within a large informed group for advancing one?s understanding. Still, the Review gave us an opportunity to place the Indian economic scene in a global context. With more than 50% of our GDP, up from 19% in 1991, now being accounted for by external sector transactions (merchandise trade plus invisible payments and receipts), it is indeed time that all our policy formulation, including the Five Year Plans, should be firmly located in the global context. Unfortunately, this is not yet the case.
As part of the global context, we made a few inevitable comparisons with China. One well known feature that is nevertheless worth emphasising is the rather sharp difference in the contribution of net exports to GDP growth. In China, this has increased from 6.2% during 1993-2000 to 7.5% during 2001-2005. In India?s case, the contribution of net exports was a negative 2.5% during 1993-2000, which increased to (-) 4.9% during 2001-07. In other words, the mix of our policies and performance, in net terms, is generating employment and capacity expansion in other countries to meet domestic demand!
This would be fine if our domestic savings were weak and stagnating, but with savings now on a sharply rising trend and absorption of capital flows becoming increasing costly, it is time that policy attention be even more sharply focused on achieving a net export surplus and making external demand an impetus for growth. Given that our exports have so far been relatively labour intensive, this external demand based growth will also generate more employment and be more inclusive.
Additionally it is worth pointing out that the contribution of consumption expenditure to GDP growth in China has declined from 63.2% over the 1993-2000 period to 37.6% in 2001-2005. Investment?s contribution increased from nearly 30% to 54.4% over the same period. China is clearly creating huge capacities for future growth. With this massive expansion in infrastructure and productive capacities, combined with about 200-300 million Chinese still awaiting major productivity gains by moving from agriculture to manufacturing and services, China can be expected to achieve high growth rates for the next 50 years. Any expectation that China will run out of steam due to adverse demographics, wage increases or large-scale excess capacity should be discarded.
The data reveals that the Indian economy?s dependence on consumption expenditure is also declining, though not as sharply as in China. Consumption contribution to GDP growth has declined from 75% in 1993-2000 to 59% in the latest period (2001-2007). This has seen a rise in investment expenditure?s contribution from 26% to 46% over the same period. This is indeed a positive trend that is likely to continue, thanks to the country?s favourable demographic structure. However, as larger numbers enter their productive years, accessible education, especially vocational education, and external demand (read exports of goods and services), would have to help generate the requisite employment.
Traditional macroeconomic theory had it that capital flows help to balance the economy?s balance of payments by compensating for changes in the current account. This has now been stood on its head, with capital account flows bearing little relation to the current account. How does one otherwise explain the fact that in 2007-08, according to our conservative projections, India is likely to receive $123 billion of capital inflows that will result in an increase of $104 billion in the reserves? These will reach about $365 billion by the end of March 2008, putting tremendous upward pressure on the rupee. The current account deficit for 2007-08, on the other hand, is expected to be a modest (-) 1.6% of GDP ($18.9 billion), with a merchandise trade deficit of $91 billion being almost fully covered by an invisibles surplus of $72 billion.
It is clear that these huge unsolicited inflows can be traced to treasury managers, portfolio funds and speculators trying to cash in on the ?India story?.
The capital account?s link with the real economy has been snapped. This calls for a reworking of our own understanding of how to handle these flows and devise independent policy instruments to handle them to keep them broadly in line with the economy?s requirements. Therefore, unless critical issues in improving the investment environment, deepening the financial sector and reducing the infrastructure deficit are adequately addressed, it will be prudent and pragmatic to restrict these capital inflows by using well known and proven measures (see the last column of Ethical economics). We may otherwise find ourselves being at the mercy of financial market operators whose understanding of India?s economy is derived perhaps from a two-day visit once every two years, and who may be given to herd behaviour. God forbid.
?The author is director & chief executive of Icrier, a Delhi-based thinktank, and member of India?s National Security Advisory Board
