A review of the Indian Economy in the recent period throws up several interesting insights. Economic growth has averaged 7.3% per annum over the last decade. Our external payment situation has been comfortable even though the current account deficit has started widening in the last few years. Our Foreign exchange reserves are robust; however, one disturbing element is the rise in inflation in the recent period. There are many challenges on the way forward. We need to sustain the present rate of growth if not accelerate it to higher levels.
We need to translate growth into poverty reduction. In other words, we need to generate poverty reducing growth that is a growth process to which the poor can contribute and from which the poor can also benefit. We need to expand employment opportunities and improve productivity across all sectors of the economy. We need to narrow the economic dispari-ties across and within states without compromising efficiency. We need to improve the social indicators as well. India still ranks a low 119th in the UNDP human development index in the bottom one-third of the League of Nations. The agenda for achieving growth and poverty reduction is thus formidable requiring as it does not only in identifying the areas of action but also in effective and efficient implementation of the policy agenda.
The year 1991 is an important landmark in the post independent economic history of our country. The country faced an acute economic crisis triggered by a severe balance of payment problem but the crisis was converted into an opportunity to bring about some fundamental changes in the content and approach to economic policy. That the content and process of our economic reforms are in the right direction is indicated by the performance of the economy in the postreform period. Between 1981-1982 and 1990-1991 that is the decade before the reforms were introduced, the economy grew at 5.6% per annum on a compound average basis. Between 1992-1993 and 2009-2010 the economy grew at an average 6.81% per annum a significant improvement over the prereform period.
Coming to the more recent period, economic growth in the five-year period starting 2005-2006 and ending with 2009-2010 despite the crisis effect in the year of 2008-2009 was at an average of 8.64%. This clearly represents acceleration in the rate of growth and marks a distinct break. Under the severe impact of the global crisis the India economy registered a growth rate of 6.7% in 2008-2009 after having registered a growth rate exceeding 9% for three consecutive years. By any standards the Indian economy was able to protect itself reasonably well in the conditions of the international financial crisis. The growth rate picked up in the next year and the economy grew at 8% in 2009- 2010. Disaggregating this growth rate it is seen that the growth rate in agriculture was 0.4% that of industry 8% and that of services 10.1%.
The growth rate of 8% in 2009-2010 is extremely significant looking at the fact that we had one of severe draughts in the recent period in that year. The growth rate of the Indian economy is now estimated at 8.5% for 2010-2011. There has been a substantial jump in agricultural production. The monsoon was good and therefore the agricultural GDP had grown at a rate exceeding 6.6%. Industrial production was very strong in the first half of the year but then it slackened particularly in the last quarter but the growth of the manufacturing sector for the year as a whole is 8.3% with a jump in agricultural production and with industry growing at 8% and the services at 9.4%. The overall growth rate for the year that has just ended is 8.5%. It is my view that the Indian economy will grow around or close to 8.5% in 2011-2012. The agricultural growth rate will be moderate because it is not possible to grow at the same rate as we did last year but the industry and services sectors will grow between 8 and 9% to give us an overall growth rate of 8.5% in 2011-2012 as well.
In this context the frequently asked question is whether India has the potential to grow at 9% per annum in a sustained way. India’s savings rate has crossed 34% on GDP. The investment rate has exceeded 36% of GDP. Even with an incremental capital output ratio of 4:1 and this should enable the Indian economy to grow at 9% thus the macroeconomic parameters relating to savings and investment are conducive to achieving a high growth rate. However for this to happen we also need to remove the constraints that may come in the way but these constraints can be broadly classified into those in the short term and those in the medium term. In the short term there are three important problems, which we need to address. One relates to the taming of the inflation, the second relates to the management of the current account to the balance of payments and the third, rates of the fiscal consolidation.
I shall have more to say on inflation a little later but as far as the current account deficit is concerned India’s balance of payments position as I have mentioned earlier was comfortable and the current account deficits remained well below 2% of the GDP but last year in 2010-2011 it was found that in the first half of the year the current account deficit was running at a high level and it was feared at one time that the overall current account deficit for the year may exceed 3%, but however, the short pickup in the exports finally resulted in the current deficit being around 2.5% of GDP. Over the medium term, we need to manage our current account in such a way that the overall current account deficit does not exceed 2.5% of the GDP.
So far we have had no problem in financing the current account deficit, the capital inflows have been adequate to cover the current deficit. The capital inflows whether it being in the form of foreign direct investment or FII inflows or external commercial borrowing have been adequate to cover the current account deficit. Nevertheless, I think over a longer period of time, it is desirable to keep the current account deficit below 2.5% of the GDP. Fiscal consolidation has also become important because over the medium term it is only in the context of strong fiscal consolidation program the medium term growth can be maintained at a high level.
In the medium term there are two sectors which pose the major challenge and these are the farm economy and the other in my view is the power sector. The first of these the farm economy is primarily constrained by the relatively low levels of yield in the major cereal crops and pulses as compared to other Asian economies especially China. We have a large science and technology establishment for agricultural research but the results in terms of productive gains have much to be desired. We need to take necessary steps to revitalise the traditional crop agriculture which is vital to food security and formal income equally as shifts in demands occur on the part of the consumers agricultural production must also respond to them as I believe that the last few years have clearly shown how even a short fall in the agricultural production can bring about serious distortions in the economy and therefore the emphasis on the farm sector is extremely relevant and crucial as far as maintaining the economic growth is concerned.
The second challenge for the country is the shortage of physical infrastructure of which the single most important element is electricity or power. Shortage of electric power leads not only to direct production loses but also results in inefficiency in a broad range of areas impacting profitability and competitiveness. Of course a data indicates that in the first four years of the 11th plan we have added more capacity than what we did in the first four years of the 10th plan. Nevertheless the capacity addition has fallen short of the targets fixed in the 11th plan and it is extremely important that we strive and try to ensure that the targets set for the power generation and for capacity creation are met. In this context, I need to say that it is remarked that China adds in one year to capacity creation what we do in five years. That is the kind of divergence between what some other countries are able to do. It is extremely important as I mentioned earlier for maintaining a rate of growth of 9% per annum in a sustained way over the medium term we need to pay special attention to the power sector. We have had two years of high inflation. 2009-2010 was badly affected because of the deficient monsoon. Food grain production, a decline by 17 million tons and as a consequence inflation was triggered by the increase in the food grain prices. Inflation as measured by the Wholesale Price Index touched the peak of 11% in April of 2010.
We had expected that inflation would come down through 2010-2011. In fact it started happening, but by November 2010 the prices started rising. As of March 2011 year-on-year inflation was 9% while the food price inflation of 2009-2010 was triggered by the rise in the food grain prices, in 2010-2011 it was triggered by the rise in the prices of vegetables, fruits, eggs, meat, and fish. I think this is an important distinction between the behaviour of prices in 2009-2010 and 2010-2011. 2009-2010 phenomenon easily explains in terms of decline in agricultural production, food grain production by almost 17 million tons in that particular year. In 2010-2011 in fact the cereal prices did not increase. In fact even as of a recent period the year-on-year increase in rice and wheat is very small and in the case of pulses the year-on-year increase is negative.
Therefore, in 2010-2011 it was triggered by the increase in the prices of vegetables, fruits, milk, and other commodities. The increase in the vegetable prices has been extremely significant. The late trains had a severe impact on the supply of vegetables including onion. The last few months have seen a decline in trend in food grain and vegetable prices and it is expected that inflation will come down in the coming months even though it may remain at a high level for some time and hopefully we can see the inflation rate coming down to the range of 6.5% by March 2012. In the early decades after independence the argument that the inflation was endemic in economic growth led to very sharp increase in prices. In the 1970s inflation was 9% and in 1980s it was 8%. We should not let that happen in the years of high growth. We must remain committed to maintain inflation at the low level. High growth in my view does not warrant high level of inflation. We must use all our policy instruments, fiscal policy, monetary policy, direct intervention in the grain market to bring down the current inflation and re-anchor the inflation expectation to the more comfortable zone of 4 to 5%.
India has travelled through a remarkable journey in the last two decades. Seeing purely from the angle of growth the performance has been very impressive. In the 9th plan the annual growth rate was 5.5%. It closed to 7.5% in the 10th plan and to an estimated 8.25% in the first four years of the 11th plan. In this context it is being asked at what rate we should aim to grow during the 12th fiveyear plan. As mentioned earlier with the investment rate touching 38% of the GDP, the economy should be able to grow between 9 and 9.5% comfortably. Pushing the economy beyond this will run into serious problems. First of all, it will be difficult to maintain or to achieve the required investment rate of 40%, which is what would be demanded if you want to grow at 10%. Secondly, pushing the economy beyond its capacity would result in strong inflationary pressures re-emerging. The deficit in the current account or balance of payment will also widen. It is therefore, prudent to aim at a growth rate between 9 and 9.5%. With respect of the objective of 9 to 9.5% in the growth rate in the 12th plan some concerns have been expressed from the environmental point of view. Development has many dimensions. It has to be inclusive. It must be poverty reducing and it must be environment friendly. We need to incorporate all these elements in the growth process.
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