The performance of the Indian economy since 1992-93 has been reassuring. The trend rate of growth has been steadily rising even though for the last two years we have been experiencing a slowdown. But slowdown should not cloud the fact that over the seven-year period beginning 2005-06, the average rate of growth of the economy was 8.3 per cent. We should not also underestimate the structural changes that have occurred in the economy. It has become more competitive and resilient. We should also consider the impact of declining the growth rate that the advanced economies are experiencing on the Indian economy.

After having grown at a rate exceeding 9 per cent per annum, it came down to 6.7 per cent in 2008-09. But the recovery from the impact of the global crisis is very sharp. In fact, the economy grew in 2009-10 at 8.6 per cent and the more recent data indicates that for 2011, the growth rate of the economy was as high as 9.3 per cent. In fact, it is almost 1 per cent higher than what was indicated by the earlier numbers. The growth rate has slowed down in the last two years. I think in 2011-12 the estimate is that the rate of growth was 6.2 per cent.

Reasons For Growth Optimism

We need to understand why this slowdown occurred. Perhaps the decline in manufacturing production has had an effect in the overall growth rate. The manufacturing growth rate came down to almost 2.7 per cent due to a variety of factors such as supply bottlenecks, price shocks and weak investment demand. The weak investment demand was due to a variety of factors, both economic and non-economic. Coming to 2012-13, we have yet to see the pickup in the manufacturing sector. For April-January, the manufacturing growth rate has been 0.9 per cent, even though the latest numbers for January show a sharper increase of 2.7 per cent. But it is still a long way from the kind of growth rates that we have had earlier. Taking all these factors into account, I would say perhaps the growth rate during 2012-13 may be a shade higher than the 5.5 per cent has been indicated by the Central Statistical Office.

Going ahead, I see an improvement in the performance of the economy in 2013-14 for three reasons. One, the full impact of the various measures the government has taken since September as well as the Budget measures would be seen in 2013-14 and the reversal in the investment sentiment that we are now seeing will get strengthened. Therefore, that will contribute to a pickup in investment and manufacturing. The second reason is that there is a focused attention on improving the performance and reaching the targets, both with respect to production and capacity creation in some key infrastructure sectors like coal, power, roads and railways. This will act as a great stimulant for economic growth. Third, the focus is also being laid on removing the impediments to growth. The Cabinet Committee on Investments is attempting to remove the barriers or impediments that may come in the way of speedy clearances. So taking all these factors into account I believe that the growth rate of the economy in 2013-14 could be around 6.5 per cent.

India’s Potential Rate of Growth

In this context, the question that is very often asked is, what is the potential rate of growth of the economy? Has India the ability to grow in a sustained way at 8-9 per cent? If you had asked this question a few years ago, everybody would have said yes. But in the light of what has happened in the last few years, people have some concerns as to what it is. In one sense, the term ‘potential rate of the growth’ can be interpreted as the maximum rate of growth at which the economy can grow and this is always indicated by the highest rate of growth that has been achieved. The growth rate of 9 per cent that we saw was not just a flash in the pan. We had that for three consecutive years and therefore, the potential exists. But what is it that has changed? One important thing that has changed is the savings and investment rates. In 2007-08, the savings rate was 36.8 per cent and investment rate 38 per cent. Even with an incremental capital output ratio of 4:1, this gave us something like 9-9.5 per cent economic growth. By 2011-12, the savings rate has fallen to 30.8 per cent and investment rate to 35 per cent. Clearly, these rates have fallen by 3-4 percentage points, affecting GDP growth. Therefore, if we can go back to the savings and investment rates of 2007-08, then we might be able to get back to the higher rate of growth.

Development has many dimensions. Growth is not just the only thing. It has to be inclusive, has to lead to reduction in poverty and has to be environment friendly. Even if India grows at 8 to 9 per cent per annum, India will graduate to become a middle income country by 2025. Growth has also enabled us in the last few years to embark on a number of socioeconomic safety nets

Even with 30.8 per cent of savings rate and 35 per cent investment rate, and with an incremental capital output ratio of 4:1, we should have had 8 per cent rate of growth. But we had a much lower rate of growth and that’s precisely because the slowdown in growth was much more than the slowdown in investment because that we haven’t been able to capture the full impact of the investment. The completion of projects has slowed down. That’s why despite a savings rate of 30.8 per cent and an investment rate of 35 per cent, our growth rate has not touched the 8 per cent. Therefore, in some ways the high level of savings rate and investment rate is reassuring because it essentially means that if we can make our investment effective, we can very quickly go back to the higher level of growth.

Structural Factors Push Food Inflation

What are the things that can come in the way of achieving the potential growth rate of 8-9 per cent? There are three major macroeconomic concerns. One is, of course, taming the inflation. I do believe that we have had too high an inflation for the last three years. If you set the high inflation mark at 7 per cent, we have had almost three years of high inflation. We really need to bring it down. Many people think that there is a trade-off between inflation and growth but I don’t think so. I think over the long period, high and sustained growth can occur only in a period of price stability and low inflation. True, much of the inflation that you have seen in the last three years is because of food inflation.

Food inflation isn’t foodgrain inflation now. It was true in 2009-10 but in 2010-11, the food inflation was caused by the extraordinary increases in the prices of vegetables and subsequently, the prices of meat, fish and egg have also gone up.

I believe structural factors are pushing food inflation. The minimum support price has been increased year after year and this does bring about certain structural rigidities leading to a higher price level. This can be tackled by using the foodgrain available in the public distribution system more judiciously. But I would also like to say that when food inflation persists long enough, it gets generalised and we saw this in March 2010 when the manufacturing inflation was 5.3 per cent, but by November 2011, it was 8.2 per cent. Persistence food inflation leads to the manufacturing inflation and therefore, I believe even though the inflation is triggered by foodgrain and other related food articles, there is a role for monetary and fiscal policies to contain inflation as the overall demand pressures in the system must be contained. A declining inflation gives greater room for monetary authorities and others to adopt a more easy monetary policy.

Runaway Balance of Payment Deficit

Second, the high balance of payments (BoP) deficit. Until 2008-09, our BoP was reasonably under control. In fact, there were one or two years in which we have even had a surplus. Since then it has started rising. Last year it was 4.2 per cent of the GDP and it could very well be at a higher level this year. We know that the exports have not done well and in the case of imports, bullion, i.e., gold, imports have been running at a very high level. Last year, about $58 billion worth of gold was imported. Then answer to that lies in having attractive results on financial assets and in taming inflation. Gold as being used a hedge against inflation. So far capital flows has been very comfortable. They have covered the current account deficit (CAD). On occasions there has been a mismatch between the CAD and capital flows. That was the time when pressures developed on the rupee. But overall, capital flows have been adequate. But we need to move towards a much lower level of CAD because too much dependence on external capital flows may not always be to our comfort.

The third area is linked to the second element. Fiscal consolidation is extremely important for sustaining a high growth. We are not talking of balancing the budget. We are talking of the appropriate level of fiscal deficit and that I think is 3 per cent of the GDP for the central government and perhaps another 3 per cent of the GDP for all the state governments taken together. That level is consistent with what we want the government and the private sector to do. This year, the Finance Minister has contained it at 5.2 per cent and has promised to take it to 4.8 per cent next year. His roadmap is reassuring.

Fiscal Consolidation & Subsidy Management

We need to have fiscal consolidation as part of our effort to sustain high growth. In doing that, containing subsidies plays an important part. Subsidies as a proportion to GDP until 2005-06 was only 1.3 per cent. Even in 2007-08, it was only 1.4 per cent. But in 2008-09, it became 2.3 per cent and in 2012-13, 2.6 per cent. Now the programme is to take it down to 2 per cent of the GDP in the next fiscal and further down to 1.6 per cent.

To take the fiscal deficit down to 3 per cent of the GDP, we need to act on both revenue and expenditure sides. On the revenue side, there is still scope of taking the gross tax revenue-to-GDP ratio to the 2007-08 level. The ratio has now come down to about 10.4 per cent of the GDP. We should take it back to 11.5 per cent by 2015-16.

On subsidies, the question people very often ask is, what about food security? My answer to that is, basically we should look at the total quantum of subsidy. And if in the perception of the government, food subsidies or food securities are paramount, we can completely provide for it but simultaneously we should be able to reduce other subsidies. The total quantum of subsidies can be done on the basis of prioritisation by the political system. The direct cash transfer system is one of the most efficient ways of making available the subsidies. It ensures the subsidies reach the right kind of people at the right time.

Why Growth is Essential

There are many other sectoral aspects, whether agriculture, infrastructure or power, that need to be addressed if we have to sustain growth. Development has many dimensions. Growth is not just the only thing. It has to be inclusive, has to lead to reduction in poverty and has to be environment friendly. But we should not sacrifice growth. Even if India grows at 8-9 per cent per annum, its per capita GDP will grow from the present level of $1,600 to $8,000 by 2025. That is when India will graduate to become a middle income country. It is growth which has enabled us in the last few years to embark on a number of socioeconomic safety nets. Whether it is introduction of the employment guarantee scheme, an extended food security system or a rural health mission, we have been able to mount them only because we are able to generate the resources which growth gave us. Therefore growth is important.

Equity is also important but growth and equity should not be posed as opposing considerations. They must be wheeled together to produce a coherent pattern of development and therein lies economic statesmanship.