India - The halcyon years,2003-8

Shankar Acharya

Gloom and doom is the prevailing mood as the world of global finance comes tumbling down and levies substantial collateral damage on global economic prosperity. Instead of one more sombre article on this now familiar theme, let me swim against the tide for a while and celebrate India’s economic prosperity of the past five years, 2003/4 to 2007/8. In doing so, I also hope to meet the criticism of some friends that my columns tend to dwell too much on the dark side of things (Darth Vader rest in peace). Actually, this complaint comes mostly from my Punjabi friends who are usually brimming with incorrigible optimism and gusto (even when the sky is about to fall down) and cannot sympathize too easily with my Bengali pessimism. After the Singur-Nano fiasco, they may better understand why we Bongs tend to attach low probabilities to good outcomes.

Most people know about India’s stellar economic growth in the past five years, at a scorching average annual rate of 8.8 percent (If they don’t, the finance ministry and planning commission will be happy to send them the data in multi-media). That’s a full third faster than the next best five year period in the country’s recorded history, namely in the immediate post-reform quinquennium of 1992-97, when the average growth clocked 6.6 percent .

MACRO OVERVIEW COMPARISON

(1)1992/93-1996/97 (2)1997/98-2001/02 (3)2003/04-2007/08
Economic Growth (% per year) 6.6 5.5 8.8
Inflation (GDP deflator, % per year) 9.1 5.0 4.5
Current Account Deficit (% of GDP) 1.1 0.6 0.4
Combined Fiscal Deficit (% of GDP) 7.1 9.0 6.7
Gross Domestic Investment(% of GDP) 24.2 24.3 33.6
What may be less well appreciated is India’s exceptionally strong performance on all the other major parameters of macroeconomic performance as well in the last five years. The average rate of inflation, measured by the conceptually best available indicator, the GDP deflator, was only 4.5 percent in 2003-08, half the rate recorded in 1992-97 and even lower than the inflation rate in the intervening slow growth period of 1997-2002. The most preferred single indicator of the health of a country’s external balance is the current account deficit. In 2003-08 this averaged only 0.4 percent of GDP, lower than in any other five-year period in the last 30 years.
Fiscal balance (or lack of it) is usually the commonest indicator of domestic balance in an economy, next to inflation. Since 1980 India has been a high deficit country, confounding pundits from international institutions and rating agencies by her capacity, nevertheless, to turn in strong growth and modest inflation. In 1997-2002 (post Fifth Pay Commission) the combined deficit of the centre and states had risen to an unsustainably high 9 percent of GDP. By 2003-08, corrective action by the centre and states brought the fiscal deficit down substantially to 6.7 percent of GDP, even lower than the level achieved in 1992-97. Perhaps even more remarkable is India’s investment performance in recent years. Gross domestic investment jumped to a record 34 percent of GDP in 2003-08, from a much lower plateau of 24 percent in both 1992-97 and 1997-2002. This massive investment boom was both a cause and consequence of the nation’s extraordinary growth in recent years.
What explains India’s outstanding macroeconomic performance in these halcyon years? Better scholars than I will research and debate this question for many years to come and one day there may be a consensus. For now, let me present my top five candidates for “the most important causes” of this exceptional economic performance. First, the cumulative reforms between 1991 and 2004 were absolutely crucial in releasing the country’s latent dynamism and reaping the benefits of foreign trade and capital flows. Not many reforms occurred in 2004-08, for which we will pay the price in future. Indeed, reform thrusts were rolled back in some areas, such as privatization, oil pricing, tax policy and interest rate controls. However, in one very important dimension, the present government did achieve a lot, in bringing about major reductions in the fiscal and revenue deficits of central and state governments. These reductions constitute my second of the “prime causes” for the economic boom, for they engendered a massive improvement in public savings, a large increase in loanable funds for productive investment and significantly lower real interest rates.
The third major factor was the remarkable (and unexpected) global economic expansion of 2002-07, which vindicated the benefits of globalization (of trade, technology and capital flows) by pumping up growth in many countries, including India. Fourth, for a change, India caught the bus on the global services boom, racking up rapid growth not just in software exports but in a wide range of services, including telecom, media, finance and retail. Last, but by no means least, India’s excellent macroeconomic performance was nurtured by the exceptionally deft exchange rate management and monetary policy conducted by the Reserve Bank in unusually challenging circumstances. In particular, the challenge of surging foreign capital inflows was adroitly managed without undue damage to a competitive exchange rate policy, so crucial for sustaining the boom in exports of goods and services.
“Halcyon” is an adjective usually deployed for times gone by. Its use in this piece is no exception. By March 2008 the global commodity price shock had sent India’s inflation soaring skywards. With prices of oil, fertilizers and foodgrains held down by government, sharply rising international prices meant massive and rising subsidies, which sent the hard-won achievements of fiscal consolidation for a six and took the foreign trade deficit to 10 percent of GDP. Attempts to disguise the yawning fiscal deficit through devices such as oil and fertilizer bonds proved ill-conceived and useless. As India struggled with high inflation and rising fiscal and external imbalances, the festering sub-prime-based international credit crisis exploded in September, capital inflows reversed sharply, liquidity became scarce and the spectre of a major international recession clouded India’s growth prospects (these developments are analysed in my series of articles in BS of June 26, August 14 and September 25).
So, the nasty global shocks of the last eight months have brought a swift end to my brief flirtation with Punjabi optimism. The ambient mood is more suited to my natural disposition. Growth is slowing to 7.5 percent (if we are lucky) this year and perhaps below 7 percent in 2009/10. Inflation, measured by the WPI, is in double digits for several months now. The current account deficit in the balance of payments is likely to be 3 to 4 percent of GDP. The combined true fiscal deficit may be 9 to 10 percent of GDP. And the investment rate is bound to drop. But, even as the economic indicators turn inexorably negative, let us not forget those halcyon years. Who knows when (or if) they will return.
The author is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. Views expressed are personal