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What Is India News Service
Wednesday, February 07, 2007


India Intelligence Report



 

 

 

   Is the Economic Growth Sustainable?

  If economic reforms keep pace, in the next several years, the Indian economy is expected to pass Italy, France, and the UK and become the fifth largest in the world spurred by more efficient industries competing with the global system.
     
 

If economic reforms keep pace, in the next several years, the Indian economy is expected to pass Italy, France, and the UK and become the fifth largest in the world spurred by more efficient industries competing with the global system. However, this growth will come at a huge price to the environment where five times more cars bought by Indians four times richer than they are today will demand more energy, oil, and fuel to drive the consumption. By 2050, Goldman Sachs has predicted that India will be the second largest economy in the world with only China ahead of it.

The transformation of a nation mired with inadequate infrastructure, energy, and ports are attracting the world waking up to the potential that is India. Countries are interested to sell their industrial goods, arms, nuclear plants, technology, and consumer goods to a population that is expected to get 12 per cent-- the largest, in salary hikes this year. Fuelled with increasing salary levels, Indian are buying cell phones to consumer durables to housing at a phenomenal rate.

The cost of such unprecedented growth is inflation. Already, the Reserve Bank of India (RBI) has increased interest rates to highest levels in the last four years and making money more expensive to banks and consumers. However, political compulsions have encouraged the sober Finance Minister P. Chidambaram to arm-twist public sector banks into not increasing housing interest rates. Wholesale Inflation crossed the target 5-5.5 per cent and rural inflation rates are at 10 per cent in North India which is going for elections in the next few weeks.

 
 

Given these realities, is the exploding economic growth sustainable?

The macro fundamentals are all spectacular. The gross domestic product (GDP) grew by 9.2% with an average of over 8% growth in the last four years compared to a modest 6% in the 1980s and 1990s. Unshackled by the government, Indian businesses did what they have done exceedingly well centuries before. Trade numbers have jumped to take 45% of the GDP from 17% in 1990, savings contributed 30% of economic growth, and foreign direct investment (FDI) has grown by over 33% to USD 15 billon leading many to believe that economic growth can be sustained from 8-10%. With such fundamentals, Indian businesses are naturally optimistic about their future with many of them reporting to near capacity utilization and many projecting plans to acquire companies abroad.

Despite the hype, there are many indicators that are alarming and need immediate fixes but some of them impossible to be fixed. Firstly, the spurt of new investment has created a number of new industries and manpower shortage looms large. This has led to higher pay scales eating into the cost of operation advantage that India could boast. Secondly, the RBI's quarterly review points to a concern over the credit boom with banks expanding their credit by 30% over the last year. Speculative buying of commercial property has grown by 84% and home mortgages by 32%. Thirdly, real estate properties have increased four times over the last four years for no apparent reason. Fourthly, the stock market has grown at alarmingly high speeds is already one of the most expensive in the world with 20 times the price to earnings ratio.

In true Bollywood style, the Mumbai-based movie industry known more for its drama than talent, the Indian media seems to have been caught up with its own hype and drinking its own potion. The Times of India has been the worst offender making page 3 news page 1 news and dramatizing everything from an Tata Steel's USD 11.3 billion acquisition of British steel major Corus to an burnt-out marginal actress turning celebrity because of a voyeur show of questionable reputation. With most Indians being conditioned to absorb hype and accept smoke and mirrors as reality, such sensational presentation has superceded serious debate on what needs to be done. Most television news channels are no better than Reality TV often repeating hype, influencing judicial verdicts, and opinion makers than presenting coherent opinion and facilitating informed debate.

Most Indians are not aware of the serious fork in the road that they are in. Hence, the presence of UK's Prime Minister in waiting in India is overtaken by the aforementioned burnt-out actress and the RBI's rate hike has been largely ignored in lieu of riots in Bangalore over a river tribunal award.

Many analysts would argue that the RBI's rate hike has not been well calibrated with inflation and trade, current, and budget deficits lack adequate reporting or media attention. The RBI has itself acknowledged that the current account deficits rates is really at 5% and not 3% as reported by the government since capital inflows from overseas Indians are being treated as domestic demand. Since excess demand and supply shortage (being it goods, services, talent, or staples) show up as current deficit, the swing from a 4% surplus of current account deficit in the first quarter and a 3% deficit in the second quarter is indicative of issues with the economy.

While the true current account deficit is greater than the situation in the 1990s, the risk of financial crisis is nonexistent since India has a USD 180 billion foreign exchange reserves that can continue to finance nearly a year worth of imports. However, since most of the capital inflows are through Foreign Institutional Investors (FII) and not FDI, India is at risk if there is a downward trend in risk appetite globally. But the true worry about the Indian economy is the shortage of supply and the lack of enough measures to deal with that problem. While interest rate increases can only reduce consumption and demand, it cannot bring more goods in. At the same time, since salary levels are expected to go up 12%, a marginal rate increase is not a sufficient deterrent.

Therefore, one set of analysts say that the economy could grow only at 7% to avoid inflation and overheating but another set discounts this view saying that India's past data in a protectionist era is not relevant to a post-reforms era and insist that the economy could grow at 9%. The first set warns that if the economy grows at 9%, then the issues of inflation, increased current account deficit could become worse. They charge that India does not have a genuinely independent central bank and the RBI is remotely controlled by the government which is eager to increase job growth and alleviate poverty.

These arguments have merit and need urgent addressing. However, they miss out a couple of important issues that only make their arguments stronger. The first one is that a majority of the Indian economy is under the radar and remains unaccounted. Their inclusion in the analysis will only make the matters worse since they will make the GDP larger and the share of taxation much smaller. The second point, and a much more serious one, is that the democratic system of India has fractured the nation along religion, caste, language, region, and financial lines which is then repeatedly exploited by regional parties for their personal benefit with impunity. Because of this fractured situation, national parties capable of forming and running the country have to increasingly depend on these marginal parties for support and long-term policies are often held hostage to regional or personal agendas.

While these issues look insurmountable, they also present the nation an opportunity. The nation has a choice of either remaining in an overcrowded stagnation or can adopt policies that can open up the future for its growth and betterment of its people.

[Next Part' Achieving a Sustainable Economic Growth Rate]

 

 

 

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