Expanding the Indian basket

Economic Survey for 2018-19 has just been presented. Technically, a survey is for the year that has just been completed, in this case, 2018-19. But it also presents the outcome for the next year–2019-20–and the years that will follow. This year's Survey is in two volumes. The first chapter of the first volume rightly flags private investments as the key driver for growth, jobs, exports and demand. One can write pages on the issue of jobs. The composition of growth is also important since employment growth occurs through growth itself.

What's the baseline for growth? GDP growth has been 7.2 per cent in 2017-18 and 6.8 per cent in 2018-19. The survey makes the point that real GDP growth has been an average of 7.5 per cent in the last five years, starting 2014-15. The controversy about GDP numbers being cooked up is a red herring. Let's ignore that. There can be a separate discussion on this but it's not pertinent to the issue. Therefore, depending on your perspective, you can take 7 or 7.5 per cent as the baseline rate of growth. Recently, Prime Minister set a target of India becoming a $5 trillion economy by 2024-25. Today, we are at $2.7 trillion. India's GDP is in rupees. It is converted into US dollars for purposes of making international comparisons.

Therefore, any projection about the future involves making assumptions about the exchange rate. Nominal growth is real growth plus inflation. Therefore, if one is working backwards from that target of $5 trillion, there not only has to be some assumption about the exchange rate but there has to be some assumption about inflation too. RBI's Monetary Policy Framework has an inflation rate of 4 per cent. Accordingly, this can be taken as the annual average inflation rate. Anyone can now sit down with a calculator and try out different iterations, as many people have already done. Economic Survey did its own projections and came up with the following. "Among the different modelling possibilities, assume a 0.7% increase in total factor productivity in India when compared to the U.S. and a constant real effective exchange rate. This then translates into an exchange rate of INR 75 per USD in March 2025, which implies that the Indian economy must have a nominal GDP of 375 lakh crores in March 2025. An 8% real growth rate for GDP combined with 4% inflation would deliver this nominal GDP." A constant real effective exchange rate simply means that the exchange rate depreciates to reflect the differential in the rates of inflation. Therefore, the real rate of growth will have to be 8 per cent. If you are more pessimistic than survey, about something like depreciation, you will come up with a slightly higher number, perhaps 8.5 per cent. Government's revenue and deficit reduction targets depend on nominal growth, not real. For our purposes, let's stick to real growth. A baseline growth of 7 or 7.5 per cent, to be jacked up to 8 or 8.5 per cent. An increase does not occur overnight, but incrementally, say by 0.5 per cent a year. The point is not one of achieving the target of $5 trillion but of growth being good. Even if one is interested in redistribution, there is more to redistribute because of a good growth. The government has more revenue to spend on sectors where public expenditure is needed.

We have had high rates of growth in the past. Between 2005-06 and 2010-11, we achieved real growth of 9 per cent. High growth in one year may be a flash in the pan but this was more than that. How does one get that high growth? And what can the Union government do about it? Given the reactions to the recent Union Budget and to earlier Budgets too, it is important to underline the second question. A lot of people expect the Union Budget to accomplish everything. But there are state governments–29 state governments and 7 UTs to be precise. Growth and investments do not occur in Delhi. They happen in states. Many economists will think of growth in terms of factor inputs (land, labour, capital) and productivity. However, one should remember the Seventh Schedule to the Constitution and recognise that factor markets are essentially state government subjects. This does not mean that those reforms, and more efficient factor markets, aren't desirable. But the extent to which reforms happen depends on state governments. There are plenty of endogenous sources of growth within India–plenty of slack. India is a large and heterogeneous country. How many states have had an average real GSDP (gross state domestic product) growth of more than 8 per cent between 2012-13 and 2016-17? The answer is Mizoram, Gujarat, Tripura, MP, Delhi and Karnataka. There are others that have achieved it in the odd year. For the most part, with the exception of items like railways and defence, all-India growth is nothing but state-level aggregated upwards. Hence, among major states, if growth picks up in Punjab, Kerala, J&K, Bihar, Chhattisgarh, Jharkhand and West Bengal, we should be able to easily achieve 8.5 per cent in aggregate. That federal angle apart, I used the expression Union government. That is the executive arm of the government. There is Parliament and there is the judiciary. Chapter 5 in Volume 1 of this year's survey has interesting material on reforming the lower judiciary. Indeed, those reforms must be undertaken. If the legal system, including the dispute resolution mechanism, is not efficient, the government has not been able to accomplish its primary purpose. The primary purpose of government, anywhere in the world, is to ensure security (internal and external), protection of property rights and an efficient dispute resolution system. Having said that, there are limited degrees of freedom the executive arm of Union government has in the matter.

To return to the growth issue, there are four sources of growth–government expenditure, investments, net exports (exports minus imports) and consumption. Let's recognise there are limits to government expenditure. Think of the wishlists people have. The government must spend 3 per cent of GDP on defence, 4 per cent on health, 6 per cent on education, 10 per cent on infrastructure and more can be added. But we are already at 23 per cent and all taxes collected by the government (Union and states) amount to 17 per cent of GDP. Fiscal profligacy has costs, even if those are long-term and not immediately visible. Since fiscal consolidation and deficit reduction is important, there are limits to public expenditure. When we achieved 9 per cent and more between 2005-06 and 2010-11, the external environment was kinder. The world economy was growing and so did exports. There wasn't this much protectionism and countries were not fighting tariff wars. We cannot change the external environment. Hence, the focus, also underlined in Economic Survey, should be on investments. That is also a reason why reining in the government expenditure is important. One does not want public expenditure to crowd out private investments and pre-empt household financial savings. How do we get the investment rate back to 38 per cent of GDP, as it once used to be? This is primarily about private investment but let's not forget public investments completely. How do we get the household savings rate (especially financial savings) back to 24 per cent of GDP? This is one way of viewing the problem.

There is a lot that can be written on tapping foreign savings, improving the investment climate and sentiments and easing the compliance cost of doing business. Taking those as given, let me quote Economic Survey. "Investment (Gross Capital Formation) accounts for nearly 32 per cent of GDP, within which fixed investment (Gross fixed capital formation) accounts for about 29 per cent of GDP…Decline in investment rate and fixed investment rate since 2011-12, seems to have bottomed out with some early signs of recovery since 2017-18….The decline in fixed investment until 2016-17 was mainly by the household sector, with fixed investment by public sector and private corporate sector remaining almost at same levels. The 'household' sector here includes 'quasi-corporates' as well. ..Household sector mostly invests in dwellings and other structures and the quasi-corporates invest in machinery & equipment. This decline in household sector fixed investment is due to decline in investment in dwellings. This is borne out by a decline in physical savings of household sector as well." The data given in the Economic Survey, which are factual, actually contradict some a priori impressions people have. I do agree that the worst of the investment slowdown is over.

(The author is Chairman, Economic Advisory Council to the Prime Minister)