India's Growth Target: Calculations May Go Wrong

India’s growth target: Calculations may go wrong
by Arun Kumar
The Tribune February 3, 2009

The US Congress passed President Barack Obama’s new $825 billion (82 per cent of India’s GDP) bailout package and in India the RBI announced its policy that changed little even though a lot was expected. It stated that India’s growth would marginally come down from the earlier anticipated 7.5 per cent to 7 per cent. Mr Pranab Mukherjee, while acting on behalf of the recuperating Prime Minister, backed this by saying that the economy will clock a 7 per cent rate of growth.
In contrast to this, there is little wrong with the Indian economic stance. President Obama in his inaugural speech talked of being “in the midst of a crisis”, not only because of the war but because “Our economy is badly weakened…” If India maintains a 7 per cent growth rate it will possibly be the fastest growing economy in the world in 2008-09. Now that the US economy is shrinking even at a faster rate (3.8 per cent last quarter and 5 per cent this quarter), President Obama again said that the crisis was deep. He has suggested that action has to be immediate and quick.
India’s policy makers are repeatedly asserting that the economy will only slow down slightly, implying that no major steps are required. So, even though two stimulus packages have been announced earlier, a huge supplementary budget was presented in October and the RBI has tried to increase liquidity rapidly (without much success); overall, the government is not intervening aggressively enough to boost the economy. This is in sharp contrast to the aggressive interventions not only by the US but also all the other major regions and economies of the world – Europe, Japan, Britain, China and South-East Asia.
It is being argued that India is not dependent on exports and so the effect of the global slowdown would be limited. It is said that we are dependent on internal consumption-generated demand and that is not affected by the global crisis. Further, it is being suggested that our banks are well capitalised and did not participate in the creation of the toxic assets that have plagued the major banks in the world that had resorted to high leveraging. As such, they are not expected to be adversely affected by the ongoing global financial crisis. It is also argued that while the urban areas are linked to global markets and will, therefore, get affected, the rural areas, constituting a huge market, are insulated from what is happening at the world level and so the demand will be maintained.
These arguments are a throwback to the decoupling theory, which has been discredited long back but is making its appearance in a different garb. If these explanations hold, then the government is justified in not taking drastic steps as other economies are doing. However, if these assumptions are incorrect and the government is only posturing because of the coming elections, then we are in deep trouble because if correctives are not applied in time to salvage a deteriorating situation the new government would confront a deep crisis.
It is true that agriculture employs about 50 per cent of the work-force and the rural population is 72 per cent of the total population. However, now agriculture only generates 17 per cent of the total output of the economy. Even if it grows at twice its recent rate of growth of 2.5 per cent, it can only add 0.4 per cent to the growth rate of the economy. If industry slows down from about 10 per cent to about 3 per cent then that would lower the rate of growth by 1.4 per cent.
Finally, if the services sector slows down from around 10 per cent to about 4 per cent, as appears to be likely with trade, real estate, business services, transportation and other services slowing down while very few are maintaining growth like telecommunications, banking and health services, then the rate of growth of the economy may be in the range of 3-5 per cent. In fact, the IMF has cautiously lowered its growth forecast to 5 per cent in contrast to the Indian government sticking to the 7 per cent figure. In brief, the rural market is not very large and can hardly compensate for the decline in the urban markets.
India’s share of exports in its GDP was about 20 per cent in 2007 according to the WTO figures. The comparable figure for China is a whopping 40.8 per cent and for Germany 46.5 per cent. No wonder, as soon as the US recession started, these economies landed in trouble. Germany is in recession and the Chinese economy has drastically slowed down. So, it is correct to say that India will not be affected as much as Germany and China did. However, for the EU as a whole, the comparable ratio is 16.3 per cent and for Japan 19.2 per cent, both less than India’s and both have been in recession for two quarters. Does that give us any hope of escaping a rapid slowdown?
The Japanese banks were not exposed to the toxic assets like those in the US and Europe and yet they face a crisis. As the profitability of major corporations dips, defaults will start and then the bad loan portfolios of the presently healthy banks will take a hit. For instance, Toyota for the first time in its seven decades of existence has made a loss. Many other big corporations are reporting that in the latest quarter, their profits have either dipped sharply or have turned into losses. This is also true for the Indian corporates with Tata Steel, Reliance, Maruti, etc, seeing steep declines. Add to that the sharp decline in prices and activity in the real estate markets and one realises that defaults will rise in India too.
Unemployment is rising rapidly globally and the ILO is projecting a loss of 50 million jobs in 2009. These are mostly middle and upper middle class factory workers and white collar workers who used credit cards and bought against loans on which they are paying EMIs. There is a crisis brewing there. Banks have already turned cautious in India and are not lending as freely as they did earlier, and the Cabinet Secretariat has asked them to remain cautious. This is protecting them from bad loans, but when there is a steep down-turn, will there be anything safe as witnessed in Japan?
Consumption of the well-off sections has taken a sharp downturn. Reliance Retail, Subhiksha, Spencers, etc, are closing down many of their outlets. Sales of automobiles, air travel, etc, have been affected. So, internal consumption cannot be as robust as is being claimed and especially in the face of rising unemployment.
However, help is on the way from a rising fiscal deficit (by up to 5 per cent) due to a reported drastic fall in tax collections and increased expenditures, but this is likely to be offset by the rising trade deficit and the falling investments due to the slowdown and growing uncertainty.
All this raises doubts about India achieving 7 per cent rate of growth this year. In the event, as the economy performs worse than anticipated, the government’s and industry’s calculations are likely to go wrong. The contrast in action planned by other major economies is sharp. We are postponing necessary correctives like employment generation, accelerated rural development and preventing industries from closing down. Are we inviting a worst disaster by being ostrich like?
arunkumar1000@hotmail.com