The munitions for accelerating growth

Accelerating economic growth is all about raising the level of current income that is deployed in investments. In the lifeless storyboard of the economist, it is a matter of raising the investment rate, that is, the proportion of capital assets created, to GDP. In the real world of people, cattle on the streets, overcrowded trains and traffic jams, it is about new factory capacity, better infrastructure, housing and other real assets that help people achieve greater productivity and hence higher real incomes. The first does not necessarily translate smoothly into the latter ?but that is a subject for another day.

Our investment rate has barely increased over the past decade. From 20% at the start, it rose to 25% by the end of the eighties ? albeit fuelled by a big increase in the fiscal deficit. In the nineties, barring a few years in the middle, the ratio got stuck between 23% and 24%. Macro-planners in government looked glumly at this bit of the unmoving finger (with apologies to Omar Khayyam) and surmised that the pace of economic growth was also likely to have got mired at the 6-6.5% level.

Readers will recall the savants who sagely propounded that without raising the investment rate to 30% or higher, there was little hope for the sickly Indian child to jump and leap, like in China. And in the windowless room where there are no people, the only way the savants knew to raise the investment rate was to hike public investment?by hook or by crook.

On January 31, 2005 the Central Statistical Organisation (CSO) released the first estimates for investment and savings for 2003-04. What caught the headlines was the revision of GDP growth for 2003-04 from 8.2% to 8.5%. But that was not the big news. It was that CSO had estimated the investment rate for 2003-04 at 26.3% and it had revised the 2002-03 estimate upward to 24.8%. Likewise, the domestic savings rate for 2003-04 was estimated at 28.1% and that for 2002-03 revised upward to 26.1%. Magic had indeed been wrought?all un-beknownst to the bemoaning savants. Not in the lifeless world of precise thinking and abstruse language, but in the hurly- burly real world of people? good ones and bad ones?of companies and entrepreneurs, of bankers, of trade and commerce.

Of course, there are some problems with the data on capital formation?for the CSO is a bit unclear where the additional capital formation has happened?namely, how much in the private corporate sector and how much in households (i.e. unincorporated business). As a result, much of the increment has been, for the moment, accommodated under the suspense account or?as it is called in national accounts parlance?errors and omissions.

It is a bit easier to measure savings, tougher to locate where the counterpart capital assets have been created. From the domestic savings side, the CSO found that financial savings had jumped from 11.9% in 2001-02 (as also in the first estimates for 2002-03 released in January 2004) to 15.2% in the first estimates for 2003-04. The revised estimate for 2002-03 happens to be 13.1%. For the record, total savings is the sum of financial savings and physical assets created by households (and unincorporated business); the latter term also rose by 1.4 percentage points of GDP between 2001-02 and 2003-04. Now this is a whopping increase in financial savings of 3.3 percentage points of GDP over two years. Some of it went out as capital outflow to the rest of the world, to the extent of the increase in the current account surplus. But most of the increase had to have gone into financing the creation of capital assets within the country.

Was the increase in the financial savings rate an outcome of increased thrift by households? Not really, because household financial savings rose by only 0.3 percentage points between 2001-02 and 2003-04. The improvement came from a fall in the dis-savings (revenue deficit) of central and state governments by 1.8 percentage points and higher retained earnings of private corporates and non-departmental enterprises (PSUs) of 0.6 percentage points each, adding up to 1.2 percentage point of GDP. Incidentally, this quite clearly shows how improved fiscal discipline (or less fiscal laxity) can raise capital formation, and presumptively, economic growth.

But that is not all. In computing household savings, the net increase in household deposits is the starting point. This is obtained by first computing the increase in the household sector?s gross bank deposits which is then reduced by the increase in their liabilities. The idea is that households could (and do) borrow from the banking system to finance consumption?for instance for marriages, motorcycles and cars, and to that extent there is a need to adjust the gross savings downwards. However, households in this context also include unincorporated business, and some of the borrowing from the banking system may not be for consumption, but for creating productive capital assets?buying equipment, residential homes and for stocking shops. That means that financial savings are somewhat higher than is being presently reported, and the ?savings in physical assets? correspondingly smaller.

So we know today that last year?s savings rate was upward of 28% and the investment rate more than 26%. The up-tick in the pace of economic activity has been evident for more than two years now?in the sustained expansion of manufacturing output; in the rapid expansion of non-food credit; in the everyday difficulty to get a seat on a plane, or a room in a hotel. The CSO data has just conclusively proved the point. Government can do much to facilitate raising the trajectory of Indian economic growth. By paying more attention on getting specific infrastructure projects off the ground, on taking the pragmatic approach and expending less energy on the theoretical.

The writer is economic advisor to Icra