Instead of wasting its limited political capital on FDI in retail, the Centre should push for investments in infrastructure
By Nitin Desai
THE GDP figures for the first quarter of fiscal 2012 are out and show a growth rate of 5.5 percent. What is more disturbing for long-term growth is the fall in the rate of fixed investment from a peak of 32.9 percent of GDP in fiscal 2007 to 29.9 percent this quarter. Judging by these numbers, unless the new finance minister can work a miracle, this will most likely be a 6 percent growth year. Are we moving to a lower growth path?
Of course, 6 percent may not seem so low by global standards. But as economist Surjit Bhalla points out, 6 percent growth, when the rate of investment exceeds 30 percent of GDP, is comparable in terms of lost opportunity to economist Raj Krishna’s “Hindu rate” of 3.5 percent, achieved when the rate of investment was under 20 percent of GDP.
Many commentators, including yours truly, have been sceptical about the Twelfth Plan growth target of 9 percent for some time mainly because of structural bottlenecks and the risks of macroeconomic instability arising from the high fiscal deficit. Officialdom has continued to sound more optimistic mainly on the ground that the high rate of investment will lead to 8-9 percent growth, but also partly as a gaming strategy to talk up the incentive to invest.
Should we then plan for 6-7 percent growth and rely on luck (otherwise known as favourable conditions in global capital markets) to take us beyond this? And blame misfortune (otherwise known as coalition compulsions) if we do worse than that? What are the limits to growth that confront us in the medium term?
Let’s talk about the supply side. The growth of GDP cannot exceed the expansion in the production potential of the economy because of the accumulation of capital, the availability and deployment of labour, with the requisite skills to use this capital, and the productivity with which both capital and labour are used. Are there any reasons for supposing that the situation in this regard will be worse in the medium term than in the high-growth period from 2003 to 2010?
The rate of fixed investment has fallen in recent years as corporate savings and public savings have come under pressure. The rise in corporate savings as a proportion of GDP that we saw in the high-growth period is unlikely now. Public savings cannot recover any time soon as electoral and coalition compulsions remain the paramount concern of our political masters. As for aggregate capital productivity, we have to assume some worsening of the capital output ratio as the investment mix shifts towards manufacturing and infrastructure, particularly with the penchant for grandiose schemes like the Delhi-Mumbai Industrial Corridor, hugely expensive metro rail and similar projects for favoured cities, high-speed trains, etc to create what is described as world-class (and worldcost) infrastructure.
The labour situation may be better as precious little was done in the earlier high-growth period on this front and much seems to be underway now. We can count on a more rapid increase in labour productivity as the education and skill level of the workforce improves. But it will mean substantial investments by the public and corporate sector in vocational education which, so far, has been left to the tender mercies of unorganised private establishments. higher-value crops.
One can also expect a faster rate of growth of labour productivity as the non-agricultural output mix shifts towards manufacturing and, in agriculture, from staples to higher-value crops.
A Keynesian low-demand trap is unlikely in India where the fear is more of excess demand and inflation
Balancing the two sets of considerations, it would appear that at any given rate of investment, the potential rate of growth in the medium term may be about a percentage point or so lower than in the high-growth period. In order to make up for this, the rate of investment would have to be higher by about 4 percent of GDP relative to the average rate that prevailed in 2003-10. That is surely not on. So even if investment rates recover from the recent decline, a 1 percent or more reduction in the 2004-10 growth rate is very likely.
Growth potential is only an upper limit. Actual growth will fall below that depending on structural constraints to the full utilisation of capacity. In a relatively open economy like ours, such a constraint will come from shortfalls in the availability of non-tradeable goods and services and that basically refers to infrastructure. The problem here is not investment — look at the 40,000 MW of unused power capacity at a time when we have the largest blackout in history. The real constraint is the failure of policy to drive both investment and service efficiency in power, rail, ports, road transport, etc. The government would do better to use its limited political capital for a thorough reform of these key infrastructure sectors than wasting it on FDI in retail unless, of course, it believes that world-class retail stores are more important than world-class power systems.
THERE ARE two other structural constraints that need attention. The first is the need to shift the locus of investment and growth from west and south India to the Gangetic plain where much of the potential arising from labour availability can be found. The second is the need to shift agriculture decisively into higher-value production and that requires institutional arrangements for organised marketing comparable in their reach and success to what has been achieved by the co-operative dairies. A key requirement is a radical change in the Agricultural Produce Marketing Act and the Essential Commodities Act and major investments in cold chains and storage.
Finally, the possibility of demand side constraints on growth. Frankly, a Keynesian low-demand trap is unlikely in India where the fear is more of excess demand and inflation. But the composition of demand may constrain growth. Interest rate policies designed solely from the perspective of shortterm inflation management may hit investment and long-term growth. Continuing infrastructure constraints and capital account-oriented exchange rate policies may hurt potential export demand. A shift in incomes to upper income groups may limit the growth in domestic consumer demand.
The limits outlined above are policy dependent and can be avoided provided the medium-term compulsions of growth are kept firmly in view in North and South Block (and 10 Janpath too!) and on Mint Road in Mumbai. That, unfortunately, may not happen in the long election campaign ahead of us and that is the real limit to high growth.
The views expressed in this column are the writer’s own
An eminent economist, the author is a former Planning Commission member and has worked as Chief Economic Adviser in the Finance Ministry. He was also the Under-Secretary-General for Economic and Social Affairs of the UN.