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A balanced report card on the economy financial scene

By far the most widely read portions of the Reserve Bank of India’s Annual Report are those providing an exhaustive analysis of the macro economy and an assessment for the future. That the report itself is meant to be a statutory submission to the Government on the working of the RBI by its central board of directors is beside the point. Nor does it matter that the RBI nowadays disseminates its views on the economy through many reports and publications at fairly freq uent intervals.

The annual credit policy (April) is reviewed every subsequent quarter. Other publications such as the Trends and Progress in Banking also deal with macroeconomic issues. However, the views of the central bank, even if they stress much the same points, always matter, more so at times likes this when there is growing public awareness of economic issues. On the economic outlook for 2007-08, the RBI has stuck to its GDP growth forecast of 8.5 per cent even though many other institutions have projected 9 per cent or even higher growth.

Over the past few years, economic growth has been robust. Last year (2006-07) it was 9.4 per cent and in the previous year the GDP grew by 9 per cent. Altogether, during the four years ended 2006-07 the economy averaged 8.6 per cent growth. Hence the current year’s forecast is in line with recent trends.

However, expectations have never been higher. The Eleventh Plan document envisages an average growth rate of 9 per cent for the five years commencing 2007-08. The Prime Minister has visualised a double digit growth during the final years of the Plan.

According to the first quarter economic data released recently by the Central Statistical Organisation, the economy grew by 9.3 per cent during April-June. While these figures capture a modest revival in agriculture; it has been the same story of manufacturing and services sectors continuing to provide the momentum. To some, this seems an auspicious start, but it will be wrong to exaggerate the significance of the first quarter figures.

As the RBI has been constantly pointing out, inflation is a big worry even though WPI (wholesale price index) inflation has been coming down recently. Global commodity prices, especially oil prices, continue to rule high. Domestic consumers may have to share the burden soon. The consumer price index, already higher than the WPI, is bound to go up even further.

The challenge then is to hold down headline inflation below 5 per cent this year and strive over the medium term for a range of 4 - 4.5 per cent. Monetary policy measures operating on the demand side will dampen inflation, while supply-side management will have to be taken up proactively. Another big variable is capital flows which should be actively managed.

The RBI’s assessments of the prospects in agriculture, manufacturing and services merit attention even if they are familiar. The share of agriculture in the overall GDP might have come down from around 40 per cent in 1980-81 to below 20 per cent in 2006-07 but its importance can hardly be underestimated. Not just in growth statistics, but in the attainment of a variety of related objectives, agriculture counts. These include inclusive growth as well as price stability. Shortages of food items have driven up prices, necessitating large wheat imports along with other measures.

The CSO’s estimate of agricultural growth during April-June 2007 — a year-on-year increase of 3.8 per cent compared to 2.8 per cent a year ago — gives room for some optimism. The southwest monsoon, now drawing to a close, has been satisfactory. Rabi wheat arrivals in the market next year should lead to a softening of food prices.

The manufacturing sector has seen robust growth, although infrastructure remains a major worry. The rebound in industrial production that started in 2002-03 has continued, recording in the process impressive productivity gains. Services, the other star performer, has benefited from the resurgent manufacturing. The only disquieting feature is the skill shortages that are likely to constrain growth in services. The RBI says that “in order to reap the benefits of the demographic dividend, substantial expansion and reforms in the education sector would be needed on an urgent basis.”

On the management of the external sector, a bright spot in the overall macro economic management, the RBI has highlighted some issues that are peculiar to India. As in the case of many other countries, inflows of foreign exchange are larger than outflows. However, India differs substantially from some other countries.

First, domestic interest rates being higher than the return on forex reserves, there are certain quasi-fiscal costs. Second, although the fiscal deficit and public debt have declined in recent years, they are still high by international standards. Three, supply-side management has become more difficult with the rapid liberalisation of the economy and the relaxation of controls. At the same time several policy rigidities remain. With financial sector reforms moving to the next phase, it is no longer possible for the RBI to conduct its monetary policy through administrative instruments. Finally, India is one of the few emerging market economies to have current account deficits along with growing trade deficits.

C. R. L. NARASIMHAN

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