by: Aalap Parikh
The Indian economy has seen robust growth over the past decade. A growth rate hovering at the 8% mark consistently for 4 years in the face of volatile gas prices and a slowing US economy is an excellent achievement. But, unique to the Indian economic flourish has been the driving influence of domestic demand that has provided fuel to the economy.
Economic lift-off was initially provided in the mid-90s by the structural reforms introduced by the central government that liberalized large swaths of the Indian economy, extending India’s integration into the global economy. Maintaining this momentum of economic reform is imperative to sustaining the march of an economy under construction as it restructures itself from an economy that was once constrained by red-tape and a socialist inclined government into an efficient, attractive free market based financial system.
Maintenance of such a momentum over the last few years has resulted in an above trend growth rate of the economy. Q107 saw consumer demand accelerate to almost 9% YoY and growth was broad based with strong consumption, investment and imports showing a balanced economic performance that is supported by a strong domestic economy. The expansion of manufacturing at over 10% y/y is especially promising as it provides, along with the services industry, a twin tail growth machine. Simultaneously, it ensures that the beneficiaries of growth include both the, middle class service sector employees as well as the lower class industrial workers.
Growth of the Indian economy has been sourced mainly from the growth of the workforce, accumulation of physical and human capital, an increasing rate of technical change and an efficient allocation of resources across activities. The last two sources have been largely established through the liberalization of the Indian economy. Privatization and gradual opening of barriers has fostered competition domestically and internationally and a change of business principles from the social welfare priority of public companies to that of maximization of shareholder wealth and profit by privatized companies has increased efficiency and accountability across industries. FDI inflows and entry of multinationals have also lead to the introduction of new technologies and manufacturing methods that have increased the rate of technical change helping the country compete both in labor intensive and now capital intensive goods that require greater technical expertise and advanced technologies.
Growth of the workforce has been an instrumental factor that has allowed the economy to take best advantage of the expansion opportunities. The increase in the workforce has also lead to greater aggregate earnings and thus a greater aggregate of disposable income boosting the country’s GDP as demand for goods and services increases.
The fast paced growth of the economy has also created opportunities for growth in the white goods, electronics and heavy industries as increase in consumer consumption increases demand for consumer products and infra-structural growth increases demand for cement, steel and other heavy industries.
One of the major goals of the government over the last few years has been to control inflation. The importance of the control over inflation is the government’s focus on economic development and not just growth. Controlling inflation within the 5% region would safeguard the large percentage of the Indian workforce that works on an informal contractual basis as they are not compensated for inflation. It also provides a stable financial environment that would attract investment. The sudden rise in oil prices in Q2 2008 has caused inflation to skyrocket from a targeted WPI of 5% towards the 12% mark, hurting the rising middle class who form the country’s growth engine. India’s economic growth skidded to 7.9 percent in the April-June quarter, down from 9.2 percent in the same period last year.
India’s benchmark wholesale price index gained 12.34 percent in the week ended Aug. 23, slightly lower than the prior week, the government said Thursday. This time last year, annual inflation was just 3.94 percent. India’s fight against the cost push inflation (in the form of high oil prices) has primarily been handled by the Reserve Bank of India that has hiked interest rates to 9% an increase of 125 bps since April. The Prime Minister, Manmohan Singh is now aiming to increase productivity across all industries in a bid to counter inflation through supply side policies.
To sustain and continue the growth experienced over the last 4 years would require a continuation and improvement of the current economic and social policies. Although it is considered a competitive advantage, the growing population could turn into a burden on the economy. The manufacturing and services sectors are expanding at a fast rate but it needs to be seen if it will be fast enough for a country that gains 25 million more citizens annually. Even if the economy is able to create enough jobs to absorb the burgeoning workforce, the workforce needs to be qualified to accept the jobs, a task that might be hindered by the country’s inadequate supply of education of the secondary and higher levels.
The recent slew of SEZ (Special Economic Zone) proposals by the government to provide momentum to the economy has met with resistance as socialist political parties have rallied against their construction. Political conflict is another factor that could lead to roadblocks in the path of the growing economy. The Communist Party of India (an ex-member of the ruling coalition) almost forced the incumbent government to resign as they withdrew support over the Indian government’s attempts to purchase civil nuclear technology from the US government over the terms of the agreements drawn between the countries. Fortunately the ruling coalition was able to gather enough support in the Parliament to win a vote of confidence and maintain a semblance of stability. Highlighting though the fickleness of Indian politics.
The drop in productivity of agricultural land has been another problem for a few years now and could worsen in the near future. Agriculture is the sole form of employment for close to 57% of Indians. Growth in food grain production has dropped since 2003 – 2004 levels due to unfavorable monsoons as a majority of agricultural producers rely on the monsoons as their primary source of water supply. The problem of land being divided as it passes down from one generation to another has also lead to diseconomies of scale and drop in productivity. Government incentives such as provision of vocational training might help move some of the rural population to cities and alleviate stress on agricultural land. This needs to be carefully planned though as many cities, such as Mumbai are overcrowded and burdened already. Setting up a commodities market might help in providing a tool for allocation of food resources as well. “In the medium-term, the prospects for agriculture will be determined by the pace and quality of reforms in this sector; the ability to increase investment in surface irrigation, ground water recharge of aquifers, and restoration of water bodies; and developing high-yielding varieties of non cereal food and cash crops.” (Economic Survey 2006-07).
The current seesaw movement of the stock exchange is not very helpful in consolidating consumer confidence and it needs to be seen how adversely the country’s manufacturing sector is hit by the slowdown in the world economy. One major plus point that the country’s economy and especially financial sector can take away is that its banks have largely been unaffected by the sub-prime mortgage crisis and do not face the credit problems (at least not as intensely) that are causing havoc in the western hemisphere.
To successfully unleash India’s true potential, there is a need for a change in some of its fundamental institutions. The long term growth story of the country is contingent upon political, educational and social reforms that will allow for a development story that complements the growth, and ensures a sustainable national trickle down.