All Hunky Dory, Survey Sees India Back on 9% Growth Path in FY12

Services, demography & higher core spend to drive growth as fiscal virtue returns

The annual Economic Survey could have been written by Aamir Khan and titled "Aal Izz Well". It is gung ho about GDP growth rising to 9% next year, and staying there in the medium term. Services (which now have a 57.3% share in GDP) will be the main locomotive of the economy. This, plus the coming demographic dividend, will offset many policy flaws and sustain fast growth. The Survey cites a new Index of Government Economic Power, showing India is now the fifth-biggest global economic power after the US, China, Japan and Germany, and is well ahead of Britain or France. Analysts may worry about fiscal deficit, but the Survey declares India is galloping down the road to fiscal virtue. Fiscal deficit in the first three quarters of this year was just 44.8% of the level in the previous year. The Survey says the ratio of consolidated government debt to GDP, which touched 79.3% of GDP in 2004-05, will fall to 68.7% by 2013-14 and 65% by 2014-15. The recent revision of GDP data shows we have underestimated true GDP for many years, and hence have overestimated fiscal deficit. This, plus high inflation this year (nominal GDP will rise 20.3% against the expected 12.5%), means the budget estimate of fiscal deficit at 5.5% of GDP now translates into just 4.8%.
This actually reveals a dirty economic secret: inflation can in the short run be good for the government's books. Inflation erodes the real value of debt, and the government is the biggest debtor of all. However, inflation will with a lag also increase government spending. Neither this nor the prospect of rising subsidies (implied by the Food Security Act and spike in oil prices) disturbs the Survey's fiscal optimism. It does not hint at any painful fiscal squeeze to come, either on the tax or spending side. What will the government do to bring down prices? The Survey analyses the contribution of supply, demand and i n t e r n at i o n a l trends to inflation, but spells out no new initiatives. It describes the spike in vegetable prices as temporary bad behaviour, which will soon be checked by a reversion to more normal behaviour. Going forward, it expects monetary tightening and other steps to bring down inflation. Rising oil prices pose a challenge, and the Survey says India must adjust to the reality of expensive energy.
Higher infrastructure spending is another reason cited by the Survey for optimism about future growth. However, tucked away in small print is the dismal information that losses of state electricity boards are 1% of GDP (which means Rs 76,000 crore). Unaccounted leakages of electricity (theft and transmission losses) are a whopping 35% of electricity generated. No wonder, power continues to be a constraint on growth. Cost overruns in public sector projects had come down to a reasonable 12% in March 2008, but rose to 20.7% by October 2010, thanks partly to higher steel and cement prices. Land acquisition and environmental clearance need to be streamlined to expedite infrastructure, along with standardised contracts and better designed projects. Industrial production has dipped in recent months, and capital goods production has crashed. The Survey indicates gross capital formation will rise only 8.8% in 2010-11, against 13.8% in the preceding year. Yet it maintains the future is bright since the savings rate is well above 33% and so the investment rate can easily be 36.5%. Assuming an incremental capital output ratio of 4.1 (achieved in the 11th Plan), these factors alone should ensure a GDP growth of 9% in the coming years. The demographic dividend should raise savings (which tend to be especially high for people in their 30s and 40s).
The Survey adds once an economy operates close to capacity, growth depends more on skill development and innovation. It says patent applications are up from 17,466 to 36,812, and patents granted up from 1,911 to 16,061 between 2004-05 and 2008-09.
The Estimates SERVICES TO BE MAIN ENGINE
    
• 8.6% growth in '10-11, 9% in '11-12
    
• Fiscal deficit at 4.8% in '10-11
    
• 7% inflation by March end
    
• Investments to grow 8.4% in '10-11 The Proposals ROLL OUT REFORMS

• Allow multi-brand retail FDI

• Streamline land buys & environment nod for core projects

• Auction road projects Inclusive Growth ALLEVIATE POVERTY
    
• Create a National Forest Land Bank
    
• Second green revolution takes off
    
• Privatise state-run SEZs
    
• Transfer cash directly to cut leakage Worry Points INFLATION RISK LOOMS
    
• Unrest in the Middle East
    
• Widening current account deficit
    
• A crisis in developed nations
    
• Volatile capital flows Strong Attack on Subsidies
Actually, a better measure of innovation might be that global business journals have now started citing "jugaad" as a driver of Indian business success. Jugaad is simply the ability to extract more out of less in difficult conditions, and may be more important for productivity than just patents.
The Survey mounts a strong attack on subsidies for an array of goods and services, which result in huge leakages and waste. It cites studies showing 40-55% of food supplied to the public distribution system is diverted by ration shops. In effect, the Survey criticises the proposal for a Food Security Act operating through the PDS. It calls for a new approach that transfers cash to the needy-using the new technology of smart cards-instead of subsidising sundry goods and services. It suggests a start may be made by providing a cash subsidy through smart cards to kerosene beneficiaries, and then freeing kerosene prices.
The poor might not use this cash for kerosene, but that will still be better than letting the subsidy leak to shopkeepers and adulterators. The Survey emphasises it is important to treat all economic players, including the policeman, shopkeeper and citizen, as rational self-seeking agents.
If they can make some money on the side with little effort, many will do so. Many noble plans fail because of the assumption that they can be carried out by morally flawless agents or perfectly programmed robots. The problem with such programmes is not just faulty implementation but faulty conception.