False complacency

By Prem Shankar Jha

The Government has ample grounds for complacency. The 11.2 per cent growth in industrial production in January turned out not to be a flash in the pan. For industry recorded an 11 per cent growth in February too. This has pulled the annual rate of growth in the first 11 months of 1999-2000 to 7.9 per cent, almost one per cent more than the Central Statistical Office had assumed when it made its advance estimates of the growth of GDP during the year. Not surprisingly, even the usually conservative Centre for Monitoring the Indian Economy (CMIE) has raised its estimate of growth in 1999-2000 from 5 to 5.5 per cent. Most of the buoyancy has come from the manufacturing sector, which recorded a growth of 12 per cent. Over the year the output of manufactures has grown by 8.4 per cent. Exports have also picked up in February and March after a 2.3 per cent decline (year-on-year) in January, and were 9.8 per cent and 9.58 per cent higher than in the same months a year earlier. The growth rate for the whole year was thus 11.58 per cent, against five per cent in 1997-98 and minus four per cent in 1998-99. Overall, the Indian economy remains in an admirably balanced state.

Inflation averaged 3 per cent in 1999-2000, and even the sharp reduction of subsidies on oil products on March 24 led only to a 1.6 per cent blip in the wholesale price index in the beginning of April. Despite the double blow of the Kargil war and a 54 per cent rise in oil prices the balance of payments deficit has remained between 1 and 1.2 per cent. Foreign currency reserves actually increased by $4.5 billion in 1999-2000, and have continued to rise in April. One cannot therefore blame a Finance Minister who is not himself an economist, for preening himself on the performance of the economy, and claiming that 'there is a strong economic recovery under way'. Even hard-headed international lending institutions, like the Asian Development Bank, have swallowed the lure and are firmly hooked to the myth that India is about to break the 7 per cent GDP growth barrier on a sustainable basis. All these people are substituting wishes for horses.

The balance we are witnessing in the economy is one of stagnation. The key ingredient that remains missing is new investment. The total disbursement of loans by the term lending institutions grew by 12 per cent between April 1999 and January 2000, five per cent lower than the already unimpressive figure for the ten months of the previous year. January, moreover, saw a 25 per cent decline over the previous month. Sanctions of new investment also charted a similar course.

The seven- per cent rate of growth is therefore a will-o-the- wisp. It keeps floating in the air tantalisingly close to us, seemingly just out of reach. But no matter how hard we lunge at it, it eludes us. Since Dr. Manmohan Singh first laid out the achievements of the Congress after liberalisation in his Budget speech in 1996, there has been not a single finance minister, and not a single budget speech that has not forecast a seven per cent growth during the year ahead.

Only once was this prediction borne out - in 1996-97. But that happened because of an agricultural rebound from a poor monsoon year and a suspiciously high increase in the services sector - an area where calculating real growth is notoriously difficult. Since then growth has stayed firmly around the five per cent mark (after netting out the effect of the Pay Commission awards) except in 1998-99 when it topped six per cent because of a bumper crop.

The deceptively smooth appearance of the economy is concealing from the Government the fact that it will soon have to make a momentous decision. Either it can continue to tinker with small reforms at the edges of the economic and financial system and wait for the very weak forces of economic recovery to eventually pull investment out of its present slump, or use deficit financing to administer a kick to investment to restart the motor of growth.

Till as recently as three months ago I , along with most economists, had believed that the former course of action would suffice. All that was needed to revive investment was a decline in interest rates. This would lower the cost of borrowing and make loan capital cheaper. It would also bring down deposit rates and push money from bank deposits into the share market. That would revive the primary equity market and lower both the cost of and risk entailed by new investment. But interest rates have been going down since August 1998. The Bank Rate was brought down over the last two years from ten to nine and then from nine to eight per cent. The Cash Reserve Ratio and other rates also were brought down. Overall, huge sums were released into the money markets, but investment has not picked up.

This year too, the Reserve Bank has stuck to the same strategy. It has brought down the Bank Rate by one per cent from 8 to 7 per cent and the Cash Reserve Ratio from 9 to 8 per cent at the beginning of April. The latter has released Rs. 7,200 crores into the credit market. But the response of the banking system has been sluggish. The moves have brought down the average borrowing rates by barely three-quarters of a per cent. With the Prime Lending Rate still around 11.5 per cent, the minimum real interest rate of about 8 per cent is still too high.

Clearly we are reaching the limits of the reduction that the banks can make to their interest rates, while still struggling with mammoth overheads, non-performing loans and high compulsory investment in government securities. It is therefore no longer certain that the economy can be dragged out of the grip of stagnation through orthodox monetary measures alone.

Mr. Yashwant Sinha would therefore do well to consider the alternative. This is to use deficit financing to administer a kick to investment and gamble on the slack in the economy to absorb the resulting increase in demand without significantly increasing inflation. The way to do this is to follow the Chinese example and pour funds into the more than 250 infrastructure projects all over the country that are lying half completed.

The Government does not have to do this recklessly, as the Chinese did. The best way would be to create a fund out of which it lends the money directly to the projects, against escrows, bypassing the State governments. This will not only boost investment but also make the capital already locked in them suddenly productive. The revenue stream from the completed projects can repay the borrowings from this fund and still swell the State governments' coffers.

It is worth remembering that the Chinese government spent $12 billion on such pump priming in the second half of 1998. It increased investment in fixed assets by 22.7 per cent in the first quarter of 1999 over the same period of the previous year. The sharpest rise was in agriculture (122 per cent) followed by transport and telecommunications (46 per cent) and housing (35.5 per cent). Most observers believe that this helped shore up China's sagging growth rate by as much as three per cent in 1998 and a similar rate in 1999.

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