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Indian economy: Signs of recovery visible

Ashok K Lahiri

At long last for the Indian economy, a growth recovery beyond 4-5 per cent may be already on its way. There was some pick-up in growth through 2001-02 itself.

After a disappointing start in the first two quarters, growth accelerated from 3.4 per cent and 1.5 per cent in the third and fourth quarters of 2000-01 to 6.2 per cent and 6.4 per cent, respectively, in the same period of 2001-02.

Infrastructure bottlenecks and the lack of fiscal consolidation continue to drag down economic growth, but these problems have troubled us for at least two decades. There have been improvements in several sectors.

For example, power generated per Rs 1,000 crore of GDP at constant prices rose from 407 million kwh in 1996-97 to 431 million kwh in 2000-01. The availability of most infrastructure facilities is better than in 1996-97, even though in the three years leading up to 1996-97 growth was a healthy 7.3-7.8 per cent per year.

The growth in the last three years has varied between 4 per cent and 6.1 per cent. Yet encouragingly, according to The Economist (June 29, 2002), "the government is energetically building roads. Apart from boosting such industries as cement, this widens bottlenecks that constricted growth in the past. Telecommunications reform has a similar effect."

The story of the decade of the 1990s as a lost decade of fiscal consolidation is well known. In 1990-91, the year of the balance of payments crisis, we started with a consolidated fiscal deficit of the Centre and the states of 9.3 per cent of GDP.

After some patchy progress, the deficit reached 6.3 per cent of GDP in 1995-96, but then the deficit turned north again. In the aftermath of the Fifth Central Pay Commission award, the consolidated deficit reached a peak of 9.5 per cent of GDP in 1999-2000, higher than what we had started with at the beginning of the decade.

There are, however, a half a dozen reasons for optimism on the fiscal front. First, though audited figures are not yet available for the last two years, there are signs that the deficit may have stabilised and even decreased slightly in 2000-01.

Even the primary deficit - that is, the fiscal deficit less interest payments - may have been on a mildly declining path over the last couple of years.

This is welcome news, since its uneven trajectory in the past - 4.9 per cent of GDP in 1990-91, 1.1 per cent in 1996-97, and 3.8 per cent in 1999-2000 - had been a cause for some concern.

Second, in spite of the relative lack of progress in deficit reduction, policy-makers and legislators appear to be more focused on consolidation than ever before.

The Fiscal Responsibility and Budget Management Bill is still pending in Parliament. If this Bill passes, the central government will, for the first time in Indian history, be accountable for its fiscal prudence in the medium term.

Third, privatisation, which had been languishing for years, has picked up speed at the central level. The disinvestments of enterprises such as Balco, Modern Foods, and Maruti have already been completed, apparently bringing happiness all around.

Fourth, several states are drawing up medium-term fiscal programmes and cleaning up the arrears of payment problem of the state electricity boards, reflecting a long overdue realisation that proper power supply can be ensured only through sound financial management.

Fifth, the granting of government guarantees has been highly restricted in most states, thus lowering the risk of contingent liabilities devolving on them in the future.

Sixth, while the primary balance persists to be in deficit, the rate of interest on government bonds is low relative to the rate of growth of GDP.

This moderates India's debt-GDP ratio, which helps avoid a debt trap. In many Latin American countries, the debt-GDP ratio continues to rise, despite a primary surplus, simply because the interest rate is relatively too high.

There are grounds for cautious optimism on the infrastructure and fiscal fronts. This, together with low inflation, fairly attractive stock-valuations, and a strong external position, reinforces the hope for a resumption of rapid growth.

Inflation, as measured by the change in the average value of the wholesale price index (base 1993-94) over the same period last year, has continuously declined, from 8.5 per cent in December 2001 to 1.5 per cent in January 2002.

In spite of some upward pressure on prices of fruits, vegetables and edible oils, the index on June 29 at 164.4 was only 2.1 per cent over the previous year's value.

From an all-time high of 6,151 reached during February 2000, the Bombay Stock Exchange Sensex, the bellwether for equities, had been more or less on a continuous downswing until late 2001.

The Gujarat earthquake, the Tehelka episode, the UTI shivers and the September 11 attacks in the US reinforced the post-budget adverse investor sentiments that developed in March 2000. The Sensex touched an 8-year low of 2,595 during September 2001. But confidence, albeit waveringly, appears to have returned.

In November 2001, the Sensex closed at 3,288, a good 17 per cent up since September 2001. From December 2001, the Sensex has hovered between 3,100 and 3,758, with every rally tending to falter within a few weeks.

One reason for these weak rallies lies in the terrorist attack on the Indian Parliament in December 2001. Escalating border tensions and foreign travel advisories for India dampened the enthusiasm of the investor community, both inside and outside the country.

Now, with distinct signs of easing of border tension, the Sensex rally should consolidate.

The price-earnings (P/E) ratio is at around 15.7 in July 2002, much lower than the 29.4 of June 2000. It is likely that some will see the low valuation as an opportunity.

The past does provide instances of a swift turnaround in stock prices. On August 2, 1990, when Iraq invaded Kuwait, the Sensex fell by 3.4 per cent but revived by 24.6 per cent in three months, and by 58.3 per cent in the following year.

The inflow of foreign investment reinforces confidence in the growth recovery under way. Net foreign investment inflows were between $5.1 and $5.9 billion in the last three financial years, the first time such inflows surpassing $5 billion for three consecutive years.

There is resurgence of portfolio investment through the FII route as well. FII inflows, which turned negative at - $68 million in 1998-99, were between $2 billion and $3 billion in the last three financial years.

Foreign investment flows are likely to be considerable in the current financial year. The Maruti privatisation, with its attendant foreign inflow implications, is already complete. If foreign investors successfully bid for the large public sector oil companies, capital inflows will be considerable.

India's foreign reserves reached $58.8 billion on July 12. These reserves, representing over a year of imports, provide a fair cushion against external vulnerability. Furthermore, after a gap of 23 years, there is a surplus in the current account of $1.2 billion in 2001-02. Since 1960-61, India has had a current account surplus in only three years: 1973-74, 1976-77 and 1977-78.

Do we need such large foreign reserves? Or, should we continue with the present policy stance, and try to support the resurgence of rapid growth while consolidating the gains from macroeconomic stability? Or, with such a comfortable price and external situation, should we loosen the policy reins?

(To be continued)

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