In­dian economy: that 2002 feel­ing

Mint Asia ST - - Theirview -

It is usu­ally bet­ter to drive with an eye on the road ahead—but an oc­ca­sional look into the rear view mirror can prove to be use­ful. So it is with the state of the In­dian economy right now.

The eco­nomic sit­u­a­tion now has strik­ing par­al­lels with that in 2002. There is macroe­co­nomic sta­bil­ity, weak­en­ing eco­nomic mo­men­tum, bal­ance sheet stress. A more de­tailed look at how the stars seemed aligned 15 years ago can of­fer many im­por­tant clues about the cur­rent sit­u­a­tion.

First, eco­nomic growth was com­ing down over many se­quen­tial quar­ters. There were calls for fis­cal ex­pan­sion to boost do­mes­tic de­mand even as the gov­ern­ment seemed com­mit­ted to keep­ing its deficit un­der con­trol.

Sec­ond, in­fla­tion had come off its re­cent highs. There was a vi­brant de­bate about whether India was flirt­ing with de­fla­tion. The Re­serve Bank of India was un­der pres­sure to cut in­ter­est rates.

Third, the costs of an in­vest­ment boom funded by a credit bub­ble were be­ing felt in pri­vate sec­tor bal­ance sheets. Banks were weighed down by bad loans as project eco­nomics went awry. A new law had given lenders teeth to go af­ter loan de­fault­ers.

Fourth, the economy was highly de­pen­dent on con­sumer de­mand for its in­cre­men­tal out­put. New in­vest­ment ac­tiv­ity by com­pa­nies had al­most col­lapsed. Pub­lic in­vest­ment— es­pe­cially in road con­struc­tion—was CON­TRI­BU­TION TO ECO­NOMIC GROWTH an area of fo­cus.

A few more factors can be thrown in as well: farmer dis­tress, an ap­pre­ci­at­ing ru­pee, cor­po­rate re­struc­tur­ing.

That was then. Few now per­haps re­mem­ber how quickly the In­dian economy jumped out of the 2002 trough. Was the re­cov­ery un­ex­pected?

There were two im­por­tant cases of op­ti­mism amid the over­all gloomy at­mos­phere. Arvind Subra­ma­nian and Dani Ro­drik wrote a re­search paper for the In­ter­na­tional Mon­e­tary Fund where they put down a host of rea­sons why India could be­gin grow­ing at 7% a year on a sus­tain­able ba­sis. Vi­jay Kelkar said in his K.R. Narayanan lec­ture at the Aus­tralian Na­tional Univer­sity that the In­dian economy was on a growth turn­pike, and that it would ac­cel­er­ate in the decade ahead. All three econ­o­mists proved to be pre­scient. The In­dian economy was then mov­ing into its best run, be­fore the global fi­nan­cial cri­sis pro­vided a bit­ter (and much needed) dose of re­al­ity.

The splen­did re­cov­ery from the 2002 trough is worth re­mem­ber­ing at a time when many econ­o­mists fear that India is now trapped in a new nor­mal of slower growth. There is no guar­an­tee that what hap­pened in the past will be re­peated with karmic cer­tainty. How­ever, there are some use­ful clues for pol­icy mak­ers to­day. The data here en­cap­su­lates the struc­tural changes that took place af­ter 2002, and tells us a bit about the factors that need to be in place if the In­dian economy is to break out of its cur­rent trap.

First, the sav­ings rate as a pro­por­tion of gross do­mes­tic prod­uct went up by al­most 10 per­cent­age points be­tween 2002 and 2007—from 24.8% to 34.6%. The splen­did rise in do­mes­tic sav­ings was led by fis­cal con­sol­i­da­tion as well as an im­prove­ment in cor­po­rate fi­nan­cials. Higher sav­ings meant that the sub­se­quent in­vest­ment boom could be largely fi­nanced from do­mes­tic sources. The sav­ings rate has come down af­ter 2007—though thank­fully not all the way down to the lev­els of 2002.

Sec­ond, the In­dian economy in 2002 was like a plane run­ning on one en­gine. Al­most all the growth was com­ing from con­sumer spend­ing. Net ex­ports made some con­tri­bu­tion, but there was al­most noth­ing com­ing from in­vest­ments or gov­ern­ment spend­ing.

Now look at the sit­u­a­tion in 2007. The process of eco­nomic growth was far more bal­anced. In fact, the con­tri­bu­tion to eco­nomic growth from in­vest­ment ac­tiv­ity was higher than the con­tri­bu­tion from con­sumer spend­ing. The con­tri­bu­tion from gov­ern­ment spend­ing was mod­est since fis­cal con­sol­i­da­tion was be­ing driven by strong tax col­lec­tions. And even while net ex­ports had a neg­a­tive con­tri­bu­tion, the strength of the global economy pro­vided am­ple scope for ex­ports.

The cur­rent sit­u­a­tion is more like 2002 rather than 2007. Eco­nomic growth is again be­ing driven by con­sumer spend­ing, though gov­ern­ment spend­ing is also play­ing a small role this time around. The con­tri­bu­tion of in­vest­ments and net ex­ports is mod­est.

The In­dian economy has been served two large ex­oge­nous shocks over the past 10 months. There was de­mon­e­ti­za­tion. And then there was the tran­si­tion to the new goods and ser­vices tax. The economy should pick up some mo­men­tum once the ef­fects of these two shocks dis­si­pate.

But there is an im­por­tant les­son to be learnt from his­tory as well. India can­not raise its po­ten­tial growth rate with­out three driv­ing forces: a strong pri­vate sec­tor in­vest­ment re­cov­ery, ro­bust ex­port growth and a higher rate of do­mes­tic sav­ings. That is the key to those elu­sive ex­tra two per­cent­age points of sus­tain­able eco­nomic growth.

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