The fact that the boom in growth has been consumption-induced, services-dominated and credit-fuelled has implications for its sustainability.
WITH the release of the quick estimates of national income, which show that gross domestic product (GDP) growth in 2006-07 touched 9.6 per cent, the government can legitimately claim that the recent acceleration in growth is not a short-lived phenomenon. After taking into account the performance in 2006-07, GDP growth as estimated by the Central Statistical Organisation (CSO) averages 8.75 per cent during the four-year period from 2003-04 to 2006-07 compared with just 4.67 per cent during the first three years of this decade. And, if forecasts by the Reserve Bank of India (RBI) and other sources are an indication, the advance estimates for 2007-08 are unlikely to be below this level. Five years of near 9 per cent growth do point to a new growth story.
Underlying this turnaround in growth is a sudden step-up in the rates of investment (and saving) in the economy. Compared with an average level of 24.6 per cent during the four years from 1999-2000 to 2002-03, the gross domestic investment rate rose to 28.2 per cent in 2003-04 and then continued to climb to touch 35.9 per cent in 2006-07 a more than 40 per cent increase relative to its 2003-04 level.
Thus, explaining the growth turnaround requires identifying the factors that may have induced this sharp step-up in investment rates over such a short period. Exports are often cited as a stimulus to growth, since the rates of growth of the dollar value of exports of goods and services have been consistently high during the recent period. But it needs noting that the dollar value of exports has been high for all years during this decade except one. That is, exports were rising even when investment and growth rates were well below their recent highs and even below the levels realised during a part of the 1990s (Chart 1).
Further, if the intention is to focus on the stimulus offered by external markets, what matters is not the gross value of exports of goods and services, but net exports or exports minus imports. This is because the additional market abroad that exports deliver are partly neutralised by the fact that imports from abroad are servicing a part of our domestic market.
Net exports of goods and services from India have been consistently negative through this decade and the extent to which exports fall short of imports has risen sharply in recent years when the rate of growth has been rising. Finally, with the rupee appreciating vis-a-vis the dollar in recent times, the increase in the dollar value of exports would imply a lower rate of expansion in rupee terms and a concomitantly lower stimulus to growth.
All of this suggests that while export demand in individual sectors may have provided the incentive to invest, and that such investment would have had its multiplier effects on income, domestic demand must have been a more important driver of growth in recent years. Could investment have been the source of such demand? To argue that it has been involves making the assumption that investment is more autonomous than induced. An increase in autonomous investment would, through the direct demands it generates as well as the new incomes it creates, induce additional rounds of investment and growth.
However, conventionally it is government investment that is assumed to be autonomous, while private investment is seen to occur when pre-existing or potential demand promises profits. Thus, manufacturing growth during the late 1950s and early 1960s was seen as driven by the large public investments that the Second and Third Five-Year Plans involved. More recently, on the contrary, public investment has not been growing too rapidly. The share of the public sector in total capital formation (at constant prices) has actually fallen from 29 per cent in 2001-02 to 22.5 per cent in 2005-06, whereas that of the private corporate sector has risen from around 22.5 per cent to close to 40 per cent.
Thus, a second inference that can be derived from the evidence is that it is domestic consumption demand that is likely to have provided the inducement for private corporate investment, leading to the sharp rise in investment rates characteristic of the current growth phase. What is noteworthy is that both public and private consumption expenditures have been rising at a fast rate in recent years (Chart 2).
Understanding this consumption-led growth process requires focussing on three different components of recent growth. The first is that since growth has been accompanied by a sharp increase in domestic savings rates, implying an increase in the incomes of those who have surpluses to save, there is reason to believe that growth has been accompanied by increases in income inequality that would have implications for the pattern of consumption. This increase in inequality has also helped the government increase its direct tax collections and raise the tax-GDP ratio, allowing for an increase in government consumption expenditures despite adherence to fiscal deficit targets.
Second, partly as a result of perceived benefits from the purchase of some commodities and services (such as cell phones and mobile connections) or pressures resulting from a fall in state provision and rise in marketisation (as in the case of health-related expenditures), there has been a diffusion to lower income groups of certain kinds of privately financed consumption expenditure.
Finally, this process of diffusion of consumption of certain kinds to income groups lower than was the case earlier has been substantially aided by the credit boom that had resulted from financial liberalisation. Easy access to credit with relaxed or no income documentation requirements has not just fuelled a construction boom in housing but also resulted in a sharp increase in credit-financed consumption demand, which has driven the boom in consumption.
That these features have characterised the recent growth process is corroborated by the pattern of growth as well. A much-noted aspect of the growth process is the dominance of services in incremental income, with the growth of that sector substantially feeding on itself. Services (consisting of trade, hotels and restaurants; transport, storage and communication; financing, insurance, real estate and business services; and community, social and personal services) accounted for as much as 60 per cent of the increment in GDP during the high growth period between 2002-03 and 2006-07.
Further, the contribution of agriculture (10.75 per cent) and registered manufacturing (11.03 per cent), the real commodity-producing sectors, to the increment in GDP during this period has not been very much higher than that of construction (10.38 per cent), communication (10.46 per cent), banking and insurance (8.03 per cent) and real estate (7.71 per cent). That is, individual sectors in services have been growing as fast as the leading commodity producing sectors.
The fact that the growth has been consumption-induced, services-dominated and credit-fuelled has implications for its sustainability. If global or domestic factors necessitate a shift away from an easy finance regime, growth in consumption and construction expenditures would slow down, resulting in a deceleration in income growth. It would also curtail the boom in finance and real estate, which contribute significantly to the increment in GDP. And given the feedback effects within the services sector, the deceleration in overall growth could be sharp.
In the final analysis, growth in a poor country that bypasses the commodity producing sectors is likely to be fragile. This is a factor that needs to be taken into account when assessing the prospects of sustaining what has been a relatively long five-year boom in growth.