The Indian Economy: Current Performance and Short-Term Prospects

I. Introduction

The economic policy in India can often be dictated by political expediency as political parties indulge in competitive populism in the face of improvements in social indicators such as literacy, infant mortality and the like lagging behind rises in the rate of economic growth.

II. The Record of Economic Growth in India

By all accounts from the 15^th to the 18^th century India was one of the most prosperous regions of the world with plentiful supply of highly advanced commercial and industrial techniques (Clydesdale 2007). From 1700, however, Indian GDP per capita started to drop. India’s colonial experience was not unique since most colonies that did not result in settlements had poor records of economic growth, even stagnation Table shows levels of GDP per capita in the major European colonial powers and some colonies for about 500 years.

Levels of GDP per capita in European Colonial Powers and Former Colonies, 1500– 1998 (1990 international dollars)

	1500	1700	1820	1913	1950	1998
	European Colonial Powers
Britain	762	1405	2121	5150	6907	18714
France	727	986	1230	3485	5270	19558
Italy	1100	1100	1117	2564	3502	17759
Netherlands	754	2110	1821	4049	5996	20224
Portugal	632	854	963	1244	2069	12929
Spain	698	900	1063	2255	2397	14227
	Former Colonies
China	600	600	600	552	439	3117
India	550	550	533	673	619	1746
Indonesia	565	580	612	904	840	3070
Brazil	400	460	646	811	1672	5459
Mexico	425	568	759	1732	2365	6655
United States	526	715	880	2736	3446	18183

Source: Maddison (2006).

Thus the colonial experience was impoverishing for several colonies. Currently China’s GDP per capita is higher than India’s by a factor of almost 3 indicating that since independence India’s advantage over China has disappeared. India’s post-independence growth did not have an auspicious start, although growth has accelerated considerably of late.

In aggregate terms growth appears to have picked up significantly since the 1980s. Further, the variability of this growth (as measured by the standard deviation) has come down significantly. Per capita GDP growth which was 1.2 percent per annum during 1972-82, accelerated to 3.0 percent during 1982-92 and further to 3.9 percent during 1992-2002. In recent times it has accelerated even further. So the Indian economy has been enjoying high and relatively stable rates of growth for more than a quarter century now.

Real GDP growth was at 9.0 per cent in 2005-06 and accelerated to 9.4 per cent in 2006-07. This comes on the back of two good years for GDP growth: 8.5 per cent in 2003-04 and 7.5 per cent in 2004-05. As a consequence of such rapid growth India is now a huge market with a large and young population. As much as 95.1 per cent of India's billion plus population is below the age of 65, with almost a third being younger than 14.

Labor force is keen to enrich itself quickly and to compete with the outside world - witness India's persistent double-digit export growth in recent years. Furthermore, India's growth is likely to be less dependent on global growth than other Asian countries since it does not rely excessively on manufacturing exports. The service sector accounts for more than 31 per cent of India's exports. Thus any downturn in the global economy may have less impact on India.

One concern attending recent economic growth in India is that since it has been demand led and faces key infrastructural constraints, inflation has picked up. In particular, CPI-AL (the price index most relevant for the poor in India) has risen more rapidly than the wholesale price index or the CPI-IW. The RBI has raised the cost of borrowing successively to rein in inflation. This move seems to be having the desired effect although much will depend on the South West monsoons and the supply situation thereafter.

Factors Accelerating Economic Growth in India

The current high rate of economic growth could well accelerate further as Kelkar (2004) has opined. Contributing to this acceleration is a broad series of reforms including financial sector reforms, increased globalization and widening and deepening of product and financial markets. At the same time a benign FDI policy framework has permitted greater tie-ups in high technology areas for production for domestic as well as external markets.

Productivity Growth

The higher GDP growth rate beginning in the 1980s has been accompanied by an even sharper acceleration in total factor productivity growth. Rodrik and Subramanian (2004) examine a number of possible explanations for this rise in productivity/growth. Such explanations include Keynesian type demand-led expansion in the 1980s, the advent of the Green Revolution, and possible external and internal liberalization. Such beneficial synergies were helped by the climate of deregulation and delicensing started in the early 1990s.

Table 6 documents the acceleration in total factor productivity growth in India.

Table 6: Sources of Growth in India: Aggregate and by Major sectors (percent per year)

Aggregate Economy
				Contribution of
Period	Output	Employment	Output per worker	Physical capital	Land	Education	Factor productivity
1978-04	5.4	2.0	3.3	1.3	0.0	0.4	1.6
1978-93	4.5	2.1	2.4	1.0	-0.1	0.3	1.1
1993-04	6.5	1.9	4.6	1.8	0.0	0.4	2.3
Agriculture
1978-04	2.5	1.1	1.4	0.4	-0.1	0.3	0.8
1978-93	2.7	1.4	1.3	0.2	-0.1	0.2	1.0
1993-04	2.2	0.7	1.5	0.7	-0.1	0.3	0.5
Industry
1978-04	5.9	3.4	2.5	1.5		0.3	0.6
1978-93	5.4	3.3	2.1	1.4		0.4	0.3
1993-04	6.7	3.6	3.1	1.7		0.3	1.1
Services
1978-04	7.2	3.8	3.5	0.6		0.4	2.4
1978-93	5.9	3.8	2.1	0.3		0.4	1.4
1993-04	9.1	3.7	5.4	1.1		0.4	3.9

Source: Bosworth and Collins (2007)

Improvements in Labour Supply

Adding to the impetus for higher economic growth are certain structural changes occurring in the Indian economy – particularly on the supply side. In 2000 the proportion of the Indian population in the working age group (15-64 age bracket) was 60.9%. The UN’s Population Division has projected that this ratio will surpass the proportion of Japanese in this age group by 2012 and climb to over 66% in 30 years. At that point in time it is poised to overtake China’s population in the same age group. This is a very significant projection.

Higher Savings for Enhanced Economic Growth

Central to the growth success story has been a steady rise in India's saving and investment rates as Table 7 indicates.

Table 7: Savings and Investment in India

Savings and Investment (Base: 1999-2000) as per cent of GDP at Current Market Prices
	1999-00	2000-01	2001-02	2002-03	2003-04	2004-05	2005-06 (estimated)
Gross Domestic Savings, of which	24.8	23.4	23.5	26.4	29.7	31.1	32.4
a) Public	-0.8	-1.9	-2.0	-0.6	1.2	2.4	2.0
b) Private, of which	25.6	25.3	25.5	27.0	28.5	28.7	30.4
i) Household, of which	21.1	21.0	21.8	22.7	23.8	21.6	22.3
Financial	10.6	10.2	10.8	10.3	11.3	10.2	11.7
Physical	10.5	10.8	10.9	12.4	12.4	11.4	10.7
ii) Private corporate	4.5	4.3	3.7	4.2	4.7	7.1	8.1
Gross Domestic Investment, of which	25.9	24.0	22.9	25.2	28.0	31.5	33.8
Public	7.4	6.9	6.9	6.1	6.3	7.1	7.4
Private	17.9	16.5	16.3	18.4	19.4	21.3	23.6
Valuables	0.8	0.7	0.6	0.6	0.9	1.3	1.2
Gross Fixed Capital Formation, of which	23.4	22.8	23.0	23.8	24.8	26.3	28.1
Changes in stocks	1.9	0.6	0.2	0.7	0.8	2.0	2.9
Valuables	0.8	0.7	0.6	0.6	0.9	1.3	1.2
Saving – Investment	-1.1	-0.6	0.6	1.2	1.6	-0.4	-1.3
Public	-8.2	-8.8	-8.9	-6.6	-5.2	-4.7	-5.4
Private	7.7	8.8	9.2	8.6	9.2	7.4	6.9

Source: Economic Survey, Government of India, 2006-07

Table 8: India: Key Fiscal Indicators (per cent of GDP)

Though fiscal deficits have been coming down successive reductions have become harder to achieve. It is not clear whether the FRBMA goal of achieving zero revenue deficit by 2009 will be achieved. In the meantime public debt is nearly 75 per cent of GDP. External debt is low, with a large share in long term debt. Hence pressures on the exchange rate because of high external debt are minimal. In addition India’s foreign exchange rate reserves on 25 May 2007 stood at US$204.9 billion, a substantial part of which comes from sterilization operations to keep the exchange rate competitive for exporters.

Year	Primary Deficit	Revenue Deficit	Gross Fiscal Deficit	Outstanding Liabilities (including external liabilities at historic exchange rates)
Centre
2002-03	1.1	4.4	5.9	63.4
2003-04	-0.03	3.6	4.5	62.8
2004-05	-0.04	2.5	4.0	63.8
2005-06	0.4	2.6	4.1	63.4
2006-07 (RE)	0.1	2.0	3.7	61.5
2007-08 (BE)	-0.2	1.5	3.3	59.2
States
2002-03	1.3	2.2	4.2	32.5
2003-04	1.5	2.2	4.5	33.4
2004-05	0.7	1.2	3.5	33.3
2005-06	0.1	0.04	2.4	32.5
2006-07 (RE)	0.4	-0.01	2.6	30.3
2007-08 (BE)	-0.02	-0.4	2.1	29.2
Combined
2002-03	3.1	6.6	9.6	80.7
2003-04	2.1	5.8	8.5	81.4
2004-05	1.4	3.7	7.5	82.4
2005-06	1.0	2.6	6.6	80.5
2006-07 (RE)	0.7	2.0	6.2	77.0
2007-08 (BE)	0.0	1.2	5.3	74.2

RE= Revised Estimates BE= budget estimates

Source: Reserve Bank of India

III. India’s External Sector

Performance Another notable aspect of the recent acceleration in India’s economic growth has been its greater economic integration with the global economy. International trade reforms have proceeded rapidly in India. India is far less dependent on tariffs for government revenue but agricultural tariff reduction has not kept pace with industrial tariff liberalization.

India’s export basket is geared towards high value added items such as engineering goods (Tables 9-12).

Table 9: Growth in Exports (per cent)

Region/Country	2004	2005	2006	2007 (Q1)
World	21.2	14.1	15.5	18.5
Industrial Countries	17.3	8.5	12.6	12.9
USA	12.9	10.8	9.7	9.4
Germany	21.3	7.3	15.1	20.8
Japan	19.9	5.2	9.2	5.4
Developing Countries	27.3	22.1	19.2	25.8
China	35.3	28.4	27.2	27.8
India	28.2	29.6	21.5	12.6
Korea	31.0	12.0	14.4	14.6
Singapore	24.6	15.6	18.4	9.9
Malaysia	26.5	12.0	14.0	7.6
Thailand	19.8	14.5	18.7	17.2

Source: IMF (International Financial Statistics) and RBI.

Furthermore, the Foreign Direct Investment (FDI) regime has been further liberalized and the World Investment Report 2006 mentions India as among the top 15 recipients of FDI with improved prospects for the intermediate run.

IV. Illustrations of High Growth and Stagnation in the Indian Economy

The broadening of the base for rapid growth in the Indian economy from service to include industry has meant that there has been rapid growth of incomes. Based on repeated surveys of consumer expenditure at the household level the NCAER has suggested that real incomes are expanding rapidly as Table 13 indicates.

Table 13: Growing Prosperity – All India

Income Figures in Rs. 000 per annum at 2001-02 prices, households in ‘000 numbers

1995-96

2001-02

2005-06

2009-10

<90

131,176

135,378

132,249

114,394

91-200

28,901

41,262

53,276

75,304

201-500

3,881

9,034

13,183

22,268

501-1,000

651

1,712

3,212

6,173

1,001-2,000

189

546

1,122

2,373

2,001-5,000

201

454

1,037

5,001-10,000

103

255

10,001+

141

Source: NCAER

The projected consumption boom isn’t just restricted to urban India. On the contrary, the NCAER survey suggests that the urban demand for some relatively low-end products will be saturated by the end of the decade, while rural demand picks up.

This is reflected in higher penetration levels in rural households of almost all major items. Motorcycles are now owned by close to 8 per cent of rural households, compared with about 2 per cent 10 years ago. Over 25 per cent of rural households have TV sets, again about four times as many as a decade ago. Four per cent of rural households have refrigerators, while about 38 per cent have ceiling fans. These penetration levels too are several multiples of their magnitudes of a few years ago.

I now present some evidence of the performance of a high growth sector, automobiles

V. Emerging Constraints on Rapid Economic Growth in India

Although India’s economic growth record has been truly impressive the country does not perform as well on a broader set of human development indicators. It improved only marginally from 0.302 in 1981 to 0.381 in 1991 and 0.472 in 2001. India’s HDI rank in 2002 was 124^th – which was a deterioration on the rank (of 115^th) attained in the previous year. In 2003 there was further slippage and India was 127^th in the global ranking.

i) Increasing regional inequality

The aggregate economic growth narrative presented above masks substantial spatial variations. The regional variation in economic growth in India has remained stubbornly high despite the reforms.

Figure 4:

(ii) Rising Unemployment

An additional emerging constraint on rapid economic growth in India is the inability – at least so far - of the reforms to generate a sufficient number of jobs. India has long had problems with unemployment and underemployment. However, economic growth in the pre-reform period did impact on unemployment by raising the demand for labour. The employment elasticity of output growth was high.

In addition to open unemployment there also exists India’s persistent problem of underem- ployment. Underemployment in various segments of the labour force is quite high. The estimates of the 50^th Round of the NSS indicate that although open unemployment was only 2 per cent in 1993-94 on US basis, the incidence of under-employment and unemployment taken together was as much as 10 per cent that year.

(iii) High Fiscal Deficit

India’s fiscal deficit woes have been well documented. The combined fiscal deficit of the central and state governments has been hovering near 10 percent of GDP for quite some time now but has come down in the recent past. This figure was 9.6 percent in 2002-03, 8.5 percent in 2003-04, 8.4 per cent in 2004-05 and is estimated to be 7.5 per cent in 2005-06.

(iv) Problems of Infrastructure

India’s record in providing high quality, reliable and reasonably priced infrastructural services to its households and businesses has been inadequate. There is sufficient evidence to suggest that this state of affairs will continue for some time. Even though the potential of the private sector to meet India’s pressing infrastructure needs is largely untapped, and hence can be expanded considerably, there will continue to be a major role for the public sector in providing infrastructural services, particularly in the less developed regions/states of India.

VII. Prospects for alleviating the constraints on rapid economic growth

That rapid economic liberalization of the form that took place in China beginning in the late 1970s is difficult to achieve in India is now clear. In a democratic society tolerance for rapidly increasing inequality and slow realization of gains of liberalization for the poor is low.

Rapid rise in agricultural employment must await substantial investment – particularly in agricultural infrastructure. Employment growth in the services sector has been impressive but the capacity of this sector to absorb labour is limited. For purposes of employment expansion India will have to rediscover its latent comparative advantage in low value added manufacturing.This has been the area of most rapid growth in China and several Southeast Asian countries. India did not enter this club and imposed high tariffs on these products while at the same time producing these product domestically in “small scale industries”, many of which were granted reservations for producing specific goods. The result has been high cost production which is non-competitive both in the domestic and international markets.

After decades of high GDP growth China and Southeast Asia have moved up the value chain in manufacturing production and India could well occupy the vacated low value added manufacturing space.

The one area in which considerable progress can be expected is telecom. Mobile telephone and associated technology has grown rapidly in India. India has in excess of 50 million mobile phones with a rate of growth of 2 million phones a month. Internet access has improved considerably and there are plans to bridge the rural-urban divide in internet connectivity by rapid expansion of services in rural areas.

Some progress has also been achieved in the areas of roads. There is a substantial project to build new highways – including the so-called “golden quadrilateral” to connect the four major cities of New Delhi, Mumbai, Kolkata and Chennai with six lane expressways and supplementary feeder routes.

The functioning of ports has also recorded some improvements – partly as a result of contracting out the operations of ports to international firms with specialised expertise on this subject.

Thus the prospects for effective alleviation of the constraints facing higher economic growth are mixed but, on balance, they appear positive. However, India must continue to adopt a forward looking economic reforms program to work around some of these constraints and ensure high and stable growth can be put in place.

VIII. Conclusions

After two decades of economic reforms the Indian economy is at a crossroads. The reforms program has yielded considerable returns in the form of higher and more stable growth as well as considerable modernization of the economy. After more than two decades of impressive economic growth and some important reforms as well as deregulation, the Indian economy is at the threshold of even higher growth.

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