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The actual growth driver

A key question often asked in the context of the recent robust economic performance is which of the two, consumption demand or investment, has been the predominant growth driver. As the Economic Outlook 2007-08 prepared by the Prime Minister’s Advisory Council points out, over a four-year period beginning 2002-03, the Indian economy was first led by consumption demand but more recently it is the role of investment that is particularly significant. In the process Indi a might have avoided the pitfalls of a cyclical growth caused primarily by consumption demand. As long as there is adequate manufacturing capacity, the economy benefits from the rise in consumption demand but once the full capacity is reached bottlenecks arise. As producers acquire pricing power there are inflationary consequences leading, among other policy responses, to monetary tightening. The text book scenario has been played out in India. Banks, aided by easy liquidity during 2002-03, lent money generously to the retail sector. Certain specific asset classes, especially real estate, received a boost but amidst fears of a bubble developing, interest rates have been pushed up substantially. Fortunately, there has been no significant downturn. The EAC has predicted an impressive 9 per cent GDP growth for the current year. The obvious inference is that the sustained consumption boom has led to an investment boom that seems capable of enduring in the medium term.

There is an abundance of statistical data supporting the view that the investment boom, which might have started as early as 2003-04, has been accelerating. The investment rate — the proportion of investment to the GDP — jumped from 24.2 per cent in 2003-04 to 31.5 per cent in 2004-05 and 33.8 per cent in 2005-06; it crossed 35 per cent last year. In real terms, investment has grown at a more rapid and sustained pace, far outstripping real consumption expenditure by a wide margin during these four years. Substantial investments by the private corporate sector in fixed assets are the main reason. That is very likely to continue this year. Since incomes have grown faster than consumption, the domestic savings rate has moved up by four percentage points, making domestic financing of the new investment possible. Citing the example of the cement industry, the EAC explains how the initial pressure on prices caused by excess demand can be brought down by creating additional capacities through fresh investments. However, while “overheating” has by and large been avoided, the two problem areas of agriculture and power are critically in need of attention.

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