Recipe For 8% Economic Growth In India

Executive Summary

‘Plan the process, measure the results’

The objective of a plan is not only being efficient but being effective too. The measure of your success is directly proportional to your effectiveness. Hence, do not plan the success; plan the process and actions to become effective.

This exactly summarizes the deficiency of the Indian Planning System as pointed out by various renowned economists. The basic constraint in attaining a stable 8% growth rate is not just the policy decisions but the various measurement and implementation issues. There has been a great deal of discussion in recent years on economic reforms, but not sufficient clarity about its objectives, rationale or scope.

The principle way to realize 8% growth is through improvements in efficiency in both public sector and the private sector. However, this improvement could be materialized only by way of well planned policies and their rigorous implementation. It would be worth the effort if the entire process of implementing the plan is identified and followed at all levels. This requires sufficient political will and a minimum consensus because Bill Crosby mentioned:

I don’t know the key to success, but the key to failure is trying to please everybody

Thus, what is required on the part of the Indian state is to act on the lines of Japan and try to dissipate the image of being a soft state as noted by the Nobel laureate Kravis.

Why is 8% growth rate desirable?

Traditionally, the level of per capita income has been regarded as a summary indicator of the economic well being of the country and growth targets have therefore focused on growth in per capita GDP. In the past, our growth rates of GDP have been such as to double our per capita income over a period of 20 years. Recognizing the importance of making a quantum jump compared with past performance, and with the population expected to grow at about 1.6% per annum, planning commission requires the rate of growth of GDP to be around 8.7% over the tenth and Eleventh Plan periods.

Mckinsey reports that 6-6.5% estimate of GDP growth is insufficient to stave off swelling unemployment as the population grows. It is only higher economic growth that can reduce poverty and provide sustainable economic security and sustain a stable pace of economic development.

Thus 8% is taken to be as an intermediate target for the short run.

Achievements

From being literally in darkness at the time of independence, we have come a long way. We have gained immense success in increasing the life expectancy at birth from 32 years in 1951 to 64 years today. As against 45% of the population under poverty line in 1951, today only about 26% of the population lives below poverty line. Percentage of literate population has increased from 17% in 1951 to 65% in 2001. For 8 consecutive years, we have been exporting food grains now. There is an unprecedented creation of an impressive reservoir of scientific and technical personnel.

Though we have a long way from GNP rate of growth at 3.5% per annum in initial thirty years and per capita income rate of growth at 1.3% per annum in the same period, to about 6.5-7% GNP growth and 6% Per capita income rate of growth currently, we have miles to go. India’s improved economic performance since 1980s has substantially increased its share of world income from 3.4% in 1970s to about 4.8% now; but this is nowhere to be in comparison with China’s superior economic performance because of which it more than doubled its share from 5% to 11% over the same period. The prime reason for Chain’s success strategy is the increase in their rate of investment which increased from about 24% of GDP in 1951 to 40% today. For higher economic growth, India also requires a substantial enhancement of overall investment levels and improvement in economic efficiency.

This has become all the more difficult in this deceleration phase of economic growth. Urgent steps are needed to arrest the deceleration and restore momentum. This is proving to be difficult because it has to take place in an environment where the world economy is slowing down.

The problem was sought to be resolved during late 1980s and early 1990s. The ambitious reform program undertaken in 1991 included: significant industrial and trade liberalization; financial deregulation; improvements to supervisory and regulatory systems; and policies more conducive to privatization and foreign direct investment. These changes reawakened what Keynes called the “Animal spirits” of India’s entrepreneurs, and gave a sharp boost to growth. There has been considerable progress since then. It is summarized as follows:

- Economic growth : It averaged 6% a year, led by strong advances in the services sector. The IT industry has proven particularly dynamic and is now of global renown – and its success proves that India is perfectly capable of competing and succeeding at the top international levels.
- Poverty: During the nineties, the poverty rate is estimated to have fallen from 34% to 26%, clearly establishing the link between faster growth and poverty reduction. Measures of income inequality also declined during this period.
- Social indicators : Life expectancy has increased from 55 to 63 years; the infant mortality rate has dropped from 108 to 70 per thousand live births; and literacy has risen from 45% to 68% for men and from 29% to 45% for women.
- The external position: It has also strengthened: since the 1991 balance of payments crisis, official reserves have risen steadily and now stand in excess of six months of goods and services imports. External debt has declined to around 22% of GDP, and the current account deficit has been held to less than 1% of GDP in recent years.
- However, to say in the words of the IMF’s unofficial motto, “complacency must be avoided”.

Clouded Outlook

There is widespread agreement within India that much more needs to be done if the country is to achieve its economic potential. Growth during the past decade has not been sufficiently broadly based. Despite the impressive performance of the services sector, industrial growth – which still has the greatest potential to provide high-wage employment for the 70% of the labor force still working in agriculture – has slowed sharply since the middle of the decade.

Indian business leaders have joined a growing chorus of voices warning that India's economy is due for a sharp slowdown unless the reform process is speeded up. The environment remains less supportive than it was: the demand for exports is weaker, and the supply of capital less reliable – and to quote Governor Jalan, “Despite the relatively inward-looking nature of the Indian economy, it cannot remain insulated from these international developments.” The CII's concerns follow a wave of worries from official and unofficial quarters. Despite low and stable inflation and rising foreign exchange reserves, the country has "deep systemic maladies". The government itself is being blamed for failing to tackle the country's faltering economy, particularly in terms of cutting bureaucracy and allowing privatization.

Sustaining Stronger Growth

Indian policymakers know fully well about the important impediments to stronger growth, among them poor infrastructure, a high cost of capital, and persistent fiscal imbalances – all of which have dampened investment spending by the private sector. In addition, growth is being hampered by relatively low rates of foreign direct investment and a tendency to waste precious tax revenues on unproductive subsidies rather than worthwhile investments in, for example, primary education and health care. All these obstacles, and more, need to be tackled.

We can primarily lists the reforms under the following heads:

- Agriculture
- Industry and trade
- Services
- Social infrastructure – education, health, and the social safety net
- Economic infrastructure
- Financial sector reforms
- Fiscal situation.

Agriculture

Rangarajan estimated that a 1% increase in agricultural output tends to raise industrial production by 0.5% and augments national income by 0.7%. There is a need for the agriculture sector to grow by 4% to achieve the overall GDP growth target of 8%. This would require credit and technology flow to dry land areas by broadening the regional base of agriculture. Controls on the prices, trade and movement of agricultural commodities should be abolished. A sharp reduction in the role of government procurement agencies and the dereservation of agricultural processing would also be sensible. Thus, it is imperative on the part of India to maintain a footing in international platforms through the Agreement on Agriculture (AOA) . Variable import duties can be used to counter the effect of large variations in world prices.

Industry

The industrial sector will have to grow at over 10% to achieve the target of 8% growth if GDP. This represents a major acceleration from its past performance; the sector grew at only about 7% in 1990s. Also, industry will have to face much stronger international competition with removal of Quantitative Restrictions (QRs) and decline in the role of public sector as seen by various disinvestments. Following are the important industrial reforms needed:

- Industrial deregulation : Priorities here include eliminating preferences for small-scale producers, further easing constraints on foreign direct investment, streamlining regulatory procedures, revamping bankruptcy legislation, and privatization of PSUs.

-  Labor market reform: The repeal of legislation blocking layoffs in medium- and large-sized firms plus legislation to ease constraints on the hiring of contract labor.

- International Trade : Phased reduction in import duties, lowering tariffs of basic intermediates would help overcome the adverse effects of protection.

Services

Providing 54% of the country’s GDP, and employing 20% of the population; this sector exhibits largest productivity increases. But in a general environment of low growth and lack of demand, it is difficult to see the services sector trotting along at 8% plus. Special attention needs to be paid to this sector which is indirectly covered under social and economic infrastructure.

Social infrastructure – education, health, and the social safety net

Freedom from ignorance, disease and fear, along with freedom from want, are the best guarantors for human development. But education, health care, water and sanitation services which can ensure these freedoms are not accessible to all.

- Education:

Fifty four years after independence, literacy rates are only 68 percent for men and 45 percent for women. In China the literacy rate is 91 percent for men and 76 percent for women.

Literacy is the first step towards empowerment. Universal primary education is an effective anti-poverty measure that promotes equity. The economic returns, both private and social, on investing in education are high. A World Bank (1995) review for Asia shows these to be 39%, 19% and 20% for primary, secondary and higher education, respectively. The actions needed to achieve theses goals include improving the quality of schools with special programs for rural areas, improving physical infrastructure and making them accountable for their success.

- Health : Preventive health carewould be cost effective. There exist large regional differences. There could be cross subsidization of health care.

Economic infrastructure

The demand for infrastructure services continues to outpace supplies. Unless theses shortfalls are met by creating new capacities in power, telecom, rail, roads and ports, there would be serious constraints on faster economic growth. A wave of privatization and deregulation has been sweeping in this sector around the globe lately. This would promote improvement in efficiency and service quality. This should be encouraged. Rakesh Mohan Committee recommended:

- Existing sector specific enactments be unified into single statue
- An autonomous regulatory body for each infrastructure sector
- An Infrastructure Coordination Committee be constituted
- Special Purpose Vehicles (SPVs) used to fund infrastructure

Financial sector reforms

Having prudential and supervisory systems in place to ensure financial stability is suggested. It means ensuring that governance in private financial institutions is strong enough to ward off political interference and ensure that decisions are taken for good commercial reasons. And it means that the authorities take swift and effective action to deal with weak or insolvent institutions. India has gone a considerable way in this direction. Prudential norms have been tightened, bank capital bolstered, and the supervisory systems strengthened. India has also had the wisdom and self-confidence to submit itself to the scrutiny of a Financial Sector Stability Assessment. But, weaknesses remain, and need to be addressed. Problems with UTI, the development finance institutions, urban cooperatives, and weak banks all underline the importance of strengthening supervision, governance, and mechanisms for the resolution of non-performing loans, which are high by international standards. The government’s commitment to reduce its ownership in the financial sector is welcome and should be pursued.

Fiscal Reform

At nearly 10% of GDP, India’s general government deficit is among the highest in the world. General government debt has risen to almost 65% of GDP and all the consolidation since the 1991 crisis has been erased. A deficit this large cannot be sustained and, in the words of Herb Stein: “When something cannot go on forever, it will stop”. Unless convincing steps are taken to reduce the deficit in an orderly fashion, it will likely stop in a disorderly one with serious consequences for growth. Even if borrowing at current levels were not to cause a crisis, it is already holding the economy back by crowding out private investment and imposing a heavy interest burden on the budget, using resources that could otherwise be directed to development needs. The Fiscal Responsibility and Budget Management Bill seek to eliminate the revenue deficit over the medium term. But lasting fiscal stability will require harder budget constraints at the state government level, tax reform, reductions in subsidies and more rapid progress with privatization. Further, the so-called golden rule of a budget balanced on current expenditures has no particular analytic backing, and it would be more useful to focus on the overall deficit. International experience suggests that the payoffs will be large in terms of macroeconomic performance and the economy’s capacity to cope with shocks.

Conclusion

Many of theproposed reforms challenge the interests of privileged groups, and could involvepainful adjustments. But the long-term benefits far outweigh the short-term costs, anddelay will only increase the costs further.Indeed, India as the world’s largest democracy would alsoinspire many other countries if it were to undertake these measures, increase growthto the desired 8-9% range, and over the course of time, move out of the thirdworld.The challenge is a mighty one, but it is time for India to meet it.

References:

Prime Minister’s Economic Advisory Council

Fiscal Correction for Economic Growth – Rakesh Mohan

The Fiscal Responsibility and Budget Management Bill