One more miracle?

In the midst of the celebration over the acceleration of GDP growth, certain features of the growth trend that call for caution are often ignored. `

India, the government would have us believe, is the new growth "miracle" in the developing world. According to official figures, the growth of gross domestic product (GDP) has accelerated from its "Hindu rate" origins of around 3.5 per cent in the 1970s and earlier to 5.4 per cent in the 1980s, to 6.3 per cent during the decade starting 1992-93 and to an annual average rate of more than 8 per cent during the three years ending 2005-06. Since this acceleration has occurred in a context of limited inflation, the government is now targeting a further rise to 9 and even 10 per cent over the Eleventh Plan period.

However, in the midst of the celebration over the acceleration of growth, certain features of the growth trend that call for caution are often ignored. To start with, the 8 per cent rate of the last three years, which is the first real evidence of India's transition to "miracle" status, may be more an exception rather than the rule.

High annual rates of growth of between 7 and 8 per cent were recorded even during the three-year period between 1994-95 and 1996-97, only to be followed by a slump to the 4-6 per cent range over the subsequent six years. As a result, the trend rate of growth fell from 7.1 per cent during 1992-93 to 1996-97 to 5.3 per cent during 1997-98 to 2002-03.

Moreover, the GDP figures for the past three years are still provisional, and are likely to be revised downwards, even if marginally. Unless there are strong reasons to believe that the growth rates they reflect are robust and sustainable, it may be prudent to hold back on the celebration, which declares that higher growth is the result of accelerated reform and calls for pushing ahead with policies that increase economic vulnerability.

A second feature of significance is the structure of this growth. For some time now, the rate of growth of services GDP has been much higher than the rate of growth of overall GDP. As a result, the share of services in GDP, which was around a third in the mid-1970s, had risen to more than half by 2004-05. More than 60 per cent of the increment in GDP during 1993-94 to 2004-05 was due to an increase in GDP from services.

Services have also contributed significantly to the recent acceleration of the growth rate, with their rates of growth touching 8.2, 9.9 and 10.1 respectively in the three years ending 2005-06. Though construction has performed even better, with corresponding figures of 10.9 12.5 and 12.1 per cent respectively, given the high share of services in overall GDP, that sector would account for an overwhelming share of the higher rate of growth.

This trajectory does make India's growth experience unusual, if not unique. The sharp increase in the share of services in GDP in India has occurred at a much lower level of per capita income than that in the developed countries when they experienced a similar expansion.

There are, of course, reasons why growth in developing countries today would reflect a premature expansion of services. To start with, globally, manufacturing units today rely as much or more on management and control than on technology to raise productivity and reduce costs. This has increased the services component in manufacturing GDP.

The pressure to reduce costs leads to the outsourcing of many of these functions, resulting in the services component of manufacturing GDP appearing as a separate revenue stream and generating a consequent increase in services GDP. Inasmuch as liberalisation leads to the faster adoption of imported best-practice technologies in the developing countries, they too would tend to reflect this tendency.

Secondly, the communications revolution has cheapened the cost of communication services, resulting in a much greater and earlier use of such services. Not surprisingly, the reach of and revenues from communication services has increased substantially in developing countries, contributing to an increase in GDP from services.

Finally, the shift in emphasis in government spending from participation in production to provision of a range of public services tends to increase the share of public administration (not to mention defence) in GDP. Overall, these factors could trigger a diversification of economic activity in favour of services at an earlier stage of development than that expected on the basis of the historical experience of the developed countries of today.

However, even these factors cannot explain the Indian experience, wherein, unlike many similarly placed developing countries, GDP from services now exceeds 50 per cent of the total. Services must be growing faster than warranted by the above factors.

What seems to matter at the margin is an increase in exports rather than domestic supply (and consumption) of services. Services were earlier considered non-tradable since they required, in most cases, the presence of the supplier at the point of provision. But modern developments have made a number of services exportable through various modes of supply, including cross-border supply through digital transmission.

Such exports do seem to play an important role in India. Exports of software services, which amounted to an average of 7.1 per cent of services GDP during 2000-01 to 2002-03, stood at an average of 11.2 per cent during 2003-04 to 2005-06 and close to 14 per cent in 2005-06. Software and business (largely information technology-enabled) services dominate services exports, accounting for 52.8 per cent of the total during 2004-05, 56.1 per cent in 2005-06 and a massive 66 per cent in the first quarter of 2006-07.

There is reason to be sceptical about the sustainability of this process of services-driven growth, based on exports that are overwhelmingly directed at one or a few markets. New alternative suppliers may arise, increasing competition and reducing India's dominant market share in the outsourcing business. The threat of job losses in the developed countries may trigger a protectionist response against outsourcing of services, as is already happening in some countries. Or, a slowing of growth in the developed countries may curtail corporate spending and therefore the demand for outsourced services.

Finally, there is reason to believe that the services surge is indeed triggering inflation, which is not always reflected in the movement of whole sale price indices. The annualised month-to-month increase in the consumer price index for industrial workers, which was at or below 5 per cent for all but one of the 16 months starting January 2005, has averaged 6.8 per cent during May to September this year. Moreover, the deficit on the current account of India's balance of payments, which stood at $10.6 billion in 2005-06, when oil prices were still ruling high, has touched $6.1 billion in the first quarter of financial 2006-07 alone.

This has prompted even The Economist to declare that India's economy is overheating and that the "recent acceleration largely reflects a cyclical boom, thanks to loose monetary and fiscal policy". In its view, "India cannot grow as fast as China without igniting inflation because of its lower investment rate, particularly in infrastructure, and labour bottlenecks."

That note of caution, which predicts that the acceleration in GDP growth cannot last, is unusual for a source that has repeatedly lauded the performance of a country it sees as a tiger uncaged by liberalisation. Fortunately, there is some respect for the evidence rather than the hype at least in some quarters.