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High Savings and Investment Rates Key to Regenerate Growth

“It is true that the role of the government is changing. But the new economic policy, if I may use the expression, has not necessarily diminished the role of the government. It has redefined the role of the government”
C Rangarajan Chairman,
Economic Advisory Council

The Indian economy is currently passing through a phase of low and slow growth but it should not cloud the fact that over the eight year period beginning 2005-06 the average annual rate of growth of the economy has been 8 per cent. Most of us also overlook the fact that the Indian economy over the last two decades has assumed greater resilience and it is more competitive. Nevertheless, the question that has been asked is, what is the potential rate of growth of the Indian economy that is sustainable?

The potential rate of the growth of the economy can be linked to a highest rate of growth that the economy had reached in the recent period. For example, in capacity utilisation we take the maximum output reached in the recent period as full capacity and measure the deviation from that. But this assumption is valid only if the rate of growth achieved in the recent period is durable and is something that can be sustained.

If you look back, in 2005-06 the rate of growth of the economy was 9.5 per cent followed by a 9.6 per cent in the next year and 9.3 per cent in the following year. In the wake of the international financial crises the growth rate came down and it picked up and as late as 2010-11 it was growing at 8.9 per cent. In my view the growth that was achieved in the high growth phase was durable because if you look at other dimensions, the savings rate picked up very substantially, the investment rate in 2007-08 was 38 per cent of the GDP, the current account deficit during this period on the average of 1.1 per cent since the capital flows were large and the current account deficit was low. We added almost US$ 144 billion to the foreign exchange reserves.

That is the potential rate of growth of Indian economy and in my view the macroeconomic parameters present during that period were really indicative of this durability. So, what happened in the last two years? Two things. The savings and investment rates have fallen during this period. The savings rate has fallen down by almost 6 percentage points. The investment rate has fallen by a much smaller percentage, half a point because the current account deficit had increased during this period. But according to the latest numbers even in 2011-12 and 2012-13, the investment rate – gross fixed capital formation rate – was still 30 per cent of GDP. Given the fact that the income and the capital output ratio in the recent period has been 4:1. This should have given us a growth rate of 7.5 per cent but the actual growth rate was much lower. Why?

The major reason for this is delay in the completion of projects, maybe the lack of complementary investments or because of lack of critical inputs like coal and power. The investment has been made but the output is not coming. What is very clear from the numbers is that the decline in the output growth is much greater than the decline in the investment rate and therefore, we need to look at the factors which have been responsible for the full impact of investment being felt on output. Even at the current level of savings rate of around 30 per cent, we can get very easily to the growth rate of 7.5 per cent, if we can find our way to the speedy completion of projects, which is sought to be achieved by the Cabinet Committee on Investment and address a host of other issues. For example, environmental concerns, land acquisition issues have all become more urgent in the recent period and that is one of the reasons why there has been delay in the completion of projects.

The other aspect of the problem is that if we get back to the high savings rate and high investment rate, we can get back to the 9 per cent rate of growth. What are the possibilities? While looking at the productivity investment, we should also look at the fact that while the investment rate is still at a highly respectable level, the composition of investment has changed. Therefore, in order to get back to the high growth path of 9 per cent what are the things that are needed? First, the savings rate must go up again.

In this, the fiscal consolidation plays an important part. Second, the investment rate continues to remain reasonably high because of the high current account deficit because from something like 2.5 per cent, it rose to 4.2 and 4.8 per cent and it has come down to a very respectable level this year. But the fact of the matter is that during this slow growth period the current account deficit has increased and that is not a sustainable level. Therefore, it has to come down. Third, the productivity of capital must increase. The savings rate must go up, the current account deficit must be contained and the incremental capital output ratio must go up. That is where I think the efficiency and performance question comes in.

The investment has been made but the output is not coming. What is very clear from the numbers is that the decline in the output growth is much greater than the decline in the investment rate and therefore, we need to look at the factors which have been responsible for the full impact of investment being felt on output

It is true that the role of the government is changing. But the new economic policy, if I may use the expression, has not necessarily diminished the role of the government. It has redefined the role of the government. The role of the government has increased in some areas and it has diminished in some others. In the area of production of goods and services the role of the government has come down but its role has increased in areas where the provision of public goods has become important. That is why we need to address those issues. I would say, more market does not mean less government but different government. We need to address that if the government has to deliver in terms of delivery of public goods, in the field of public health or education we need to increase the efficiency of governance.

C Rangarajan is Chairman, Economic Advisory Council to the Prime Minister. Based on his address during release of festschrift, ‘Growth and Governance: Essays in honour of Nandan Nilekani’

C Rangarajan

C Rangarajan is Chairman, Economic Advisory Council to the Prime Minister
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