The Hindu : Is the euphoria justified?

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Saturday, Nov 08, 2003

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Is the euphoria justified?

By C. Rammanohar Reddy

There is simply no case for crowing about the performance of the Indian economy in 2003-04.

DRINKING WATER scarcity has developed in parts of Maharashtra, Andhra Pradesh and Karnataka. There are reports of acute starvation in Jharkhand. Farmers unable to cope with debt are driven to distress in Karnataka. Industrial workers retrenched from their jobs set themselves ablaze in Mumbai. Is this the same economy about which a strange euphoria is sweeping through the Government, the ruling political combine and sections of the media?

To be sure, after three years of indifferent to moderate rates of economic growth, the Indian economy is experiencing a good year. In that sense, the extent of distress — whether in a scarcity of drinking water or malnutrition or deprivation-driven suicides — is likely to be far less this year than in the past. But if events of economic distress do not tell the full story about the Indian economy this year, it is equally true that all the rosy pictures now being painted present only one side of what is happening in the economy.

The Indian economy is enjoying a bounce from the good monsoon that has blessed most (not all) parts of the country in 2003. Two sets of questions have to be asked about this recovery. One, how high is this economic bounce going to be? Two, is the recovery this year one of the usual monsoon-related upturns or does it mark the movement to a higher growth path? For the optimists, a remarkable improvement is apace in the performance of the Indian economy and this is a harbinger of a new phase of accelerated growth, which will eventually vault India into the league of developed economies. The truth unfortunately is somewhat more complicated. Consider first what the main indicators tell us about the performance of the economy so far. As is to be expected, Indian agriculture is recovering well from the drought of 2002. However, what has been ignored in the mood of self-satisfaction is that the 20 per cent jump in food production in the kharif season is not remarkable, because this is in comparison with production during a drought year. The correct comparison should be with what happened in a `normal' year. According to the first estimates, food production in the kharif season this year will be only 108 million tonnes, which is less than the 111.5 million tonnes harvested in 2001-02. There has been an improvement in industrial production, again this is only to be expected. According to the official Index of Industrial Production, output between April and August 2003 was 5.6 per cent higher than in the corresponding period of 2002. This is higher than the 5.2 per cent growth recorded in April-August 2002. An improvement, yes, but no remarkable change nor any sign of "India shining". Then there is the export sector, which recorded 9.9 per cent growth during April-September 2003. This is just half the 19.9 per cent growth rate recorded by India's exports in 2002-03. The trend is similar in the growth of bank credit. All the indicators highlighted in the Reserve Bank of India's mid-term review of the credit policy point to an increase in the flow of credit at a slower pace than last year. Until mid-October, non-food credit, bank credit and the total flow of funds to the commercial sector were all higher than last year — but were growing more slowly than in the corresponding period of 2002. Of course, most of these trends in agriculture, industry and bank credit are only of the first half of 2003-04, and could change dramatically in the second half of the year. But as of now there is a case for circumspection in making predictions about the performance of the Indian economy in 2003-04. This is what has persuaded the RBI to be cautious in its overall assessment by saying not much more than that "the growth prospects are better".

What then does one make of the overall improvement in corporate profitability as reported in the results of the second quarter (July-September) and of the rising prices of equity in the secondary market? Corporate profitability has improved because demand, boosted by the good monsoon, has increased capacity utilisation and also because lower interest rates have reduced costs. No one can deny the upsurge in profits, what is in doubt is the spread and depth of this upturn. And there is universal consensus that the current boom in the share market is being driven by foreign funds out to make a quick buck on the back of an appreciating rupee.

In sum, what we are experiencing is an economic recovery driven by a reasonably good monsoon. The precise depth of this recovery is not yet very clear. Indeed, if at all any prediction can be made it will be that going by the indicators in the first half of 2003-04, this may be a recovery which will not be as strong as in the past, whenever a "good rainfall" year followed a "poor" one. GDP growth in 2003-04 may turn out to be 7 per cent, but that would be unexceptional for a cyclical upturn. In other words, there is simply no case for crowing about the performance of the Indian economy in 2003-04.

The answer to the second question about whether or not India has entered a higher growth path can be even less ambiguous than the first one. No, there is no evidence at all that India is on the road to joining the league of developed economies. It is unfortunate that the performance of the Indian software industry and the increasing importance of India as a destination for business process outsourcing (BPO) have been used to make sweeping generalisations about India's long-term economic growth prospects. It has been pointed out many times before that it is highly unrealistic for India to pin its future on becoming the "back office capital" of the world. The size of the Indian economy and its population demand that the future still lies in manufacturing. Software and BPO can be important sources of growth, but not the only or even main sources. India's IT industry, however broadly defined, today employs at the most 500,000 people and contributes to between 1 and 2 per cent of India's GDP.

It is even more unfortunate that we build so much optimism around what phoren studies like the recent one by Goldman Sachs say about India's economic future. A study that aims to highlight the geographic locations of new investment opportunities is prepared by a financial services firm for its clients. ("Are you ready?" is the closing sentence of the study, which predicts that Brazil, Russia, India and China — BRIC — will be larger than most developed countries by 2050.) Based on some assumptions about the demographic profile of India and other large developing countries and also using notions of economies "catching up" with or "converging" on each other, it proclaims that India will be the world's second largest economy within the next half century. Such projections have no meaning whatsoever. In the mid-1990s, similar studies forecast that South Korea and Taiwan would be among the five biggest economies by 2020. After the East Asian financial crisis broke, the forecasters turned their eyes elsewhere. What beggars the imagination is how long-term problems that just six months were seen as major barriers to movement to a higher growth path have disappeared from the public discourse because the southwest monsoon of 2003 turned out to be normal. For years it was acknowledged that the growth rate of agricultural production had slowed down because investment in this sector had declined. That has not changed and yet we speak now as if all the problems are in the past. Similarly, there is no indication that the investment famine that has afflicted Indian industry since the mid-1990s has ended. It is remarkable that one strange aspect of all the excitement about improved corporate profitability and rising share prices is that few major plans for new domestic investment have been announced. Clearly long-term business expectations have not yet turned positive. Similarly, the stock market may be booming but new equity issues, which would be another sign of companies embarking on fresh investment, are conspicuous by their absence. We can afford a measure of satisfaction that 2003-04 is turning out to be a reasonably good year for the economy. But it would be unforgivable if we read too much into this temporary recovery and assume that India has found its yellow brick road to prosperity.

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