It is good to remember that India along with China and a few other developing countries has posted positive growth numbers

At the end of the year 2009 there are reasons to be optimistic about the Indian economy. The real economy and the financial markets are better than at the start of the year.

There are however pitfalls in drawing conclusions from comparing indicators such as GDP growth estimates and stock market indices over specific timeframes.

Even so, according to the widely watched indicators — the stock indices and the CSO (Central Statistical Organisation) growth estimates — the stock markets and the economy have shown resilience in the face of one of the most adverse economic environments in many decades.

It is good to remember that India along with China and a few other developing countries has posted positive growth numbers, albeit below recent trend rates, when economic growth in nearly all developed countries has turned negative.

The International Monetary Fund, the World Bank and other world bodies have acknowledged that fact and, what is more, expect the developing countries to be in the forefront of an eventual global recovery.

That is precisely what has been happening. While the U.S., Japan and most other developed countries are technically out of the recession, their growth is still anaemic. The U.S. economy is beset with high unemployment. Japan recently lowered its growth estimates sharply.

India, China fare better

On the other hand, economic news from India (and China) has been getting better by the day. In fact, at year end, there is hope that India’s GDP growth will bounce back to an annualised 8 per cent level.

The most distinguishing feature of the recent performance is perhaps not the attainment of high growth rates but the steady acceleration seen.

It has not been a steady one way upward movement of the growth estimates though.

In fact, on several occasions, sceptics have questioned the sustainability of a particular growth forecast. GDP growth in the second half of 2008-09 had come down to 5.8 per cent.

During the first quarter of the current year it had come down to 6.1 per cent but by the end of the second quarter (July-September 2009) it had recovered sharply with a 7.9 per cent growth over last year.

It is primarily based on this unexpected growth that many forecasters have started revising upward the annual growth rate for 2009-10.

As recently as in July, the Economic Survey had indicated a target range of 6.25-7.75 per cent. The wide range probably reflects the inability to make a more accurate forecast in the face of sometimes conflicting evidence.

The government’s mid-year review of the economy (December 18, 2009) expects the economy to grow even faster, perhaps close to 8 per cent.

Short-term anxieties

Two relevant issues need to be addressed here. First, is the forecast rate of around 8 per cent for the current year achievable? Second, will India get back onto a high growth trajectory and aim for double digit growth rates?

Obviously, short-term growth prospects depend on how well agriculture fares during the third quarter (October-December).

During the second quarter, when the overall growth rate was 7.9 per cent, agriculture grew by just 0.9 per cent, down from 2.7 per cent a year ago and 2.4 per cent in the first quarter.

The low growth of 0.9 per cent does not take into account the shortfall in kharif production of rice, pulses and oilseeds. The inference is that industry and services will have to fare exceptionally well to make up for the lag in agriculture.

Inflation threat

The biggest stumbling block could be inflation. With food inflation around 20 per cent, policymakers are at their wits’ end to deal with the price rise. Although this bout of inflation is traced to supplyside factors — inadequate supply of food articles in the face of rising demand — sooner rather than later monetary measures will become necessary.

Sustained rise in the prices of essential articles will push up inflation expectations further.

Besides, there will be second order effects from inflation that will spill over into the demand side, necessitating RBI intervention. In what form and when the central bank will intervene is still in the area of speculation. It may involve a CRR (cash reserve ratio) hike (to drain liquidity) and/or a hike in repo rates (short-term interest rate signals).

Indian industry and services have benefited from the stimulus packages and easy monetary stance. But these will have to be withdrawn at some point. Viewed in a larger context, the gross fiscal deficit at 10 per cent of the GDP cannot be tolerated for long.

The Finance Minister has already hinted at a return to the path of fiscal rectitude. The relatively high growth figures of the last quarter may be one other reason prompting the RBI to tighten monetary policy.

To place the current growth rate in perspective, the economy grew by 7.2 per cent on an average between 2000-01 and 2004-05 and by 9.2 per cent between 2005-06 and 2007-08.

The current growth rate is in line with the long-term trend. Regaining a 9 per cent growth trajectory will be a task for the medium-term.

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