The Economy: Foretelling The Future

BUSINESS TODAY presents Forecast 99, the Institute Of Economic Growth Development Planning Centre's macroeconomic forecast for 1999-2000.

A recession in growth is an odd way to describe an economy that has clocked the second-highest rate of growth in the whole world in 1998-99. It is appropriate, though. Although the Indian economy is forecast to grow by 6 per cent in fiscal 1999, not only has it been displaying unmistakable signs of wear-and-tear, its momentum has, definitely, slowed down. In the last 2 years, India's Gross Domestic Product (GDP) has been increasing at only 5.30 per cent per annum-a sharp drop from the 7.50 per cent it attained between 1994-95 and 1996-97.

Obviously, the rising turnover in governments, a poor harvest in 1997-98, the eruption of the Asian crisis, and the imposition of sanctions have all taken their toll. Investments shrank, business confidence plummeted, and industrial growth dipped to its lowest in 6 years. Indeed, if the Government Of India (GOI) had not chosen to award its employees a pay-hike (!), the economy's rate of growth would have fallen to 4.5 per cent last year.

There are signs that the worst may be over. Agricultural growth has rebounded, Asia is rebuilding. And, despite the lingering political uncertainty, business confidence is starting to rise. Will this be enough to propel India back onto a 7-plus per cent growth-trajectory? To find out, BT analysed the short- and medium-term forecasts prepared this year by the Institute of Economic Growth's Development Planning Centre. Our (not-so) startling finding: in the present policy environment, the Indian economy simply cannot sustain a 7 per cent rate of growth. BT presents the IEG-DPC Forecast 99:

THE GROWTH FORECAST. The downturn is over-almost. GDP growth in India in 1999-2000 will rise to 5.80 per cent-a mild acceleration over 1998-99's 5.60 per cent. Much of this will be driven by better agricultural performance. With two back-to-back bumper crops (kharif and rabi), foodgrain-production in 1998-99 hit record highs. And the primary sector should reap an even-better harvest this year, with the predictions of another normal monsoon boosting the chances of a good kharif crop. As a result, the IEG-DPC Forecast expects the growth-rate of agricultural GDP to rise from 3.30 per cent in 1998-99 to 4.70 per cent in 1999-2000.

Industry will also stage a modest recovery, according to the forecast. Propelled by a rebound in exports growth as well as a mild pick-up in investment, non-agricultural enterprises (which includes the services sector, but excludes government administration) will grow by 6.70 per cent in 1999-2000-up from 5.70 per cent in fiscal 1998. However, the additional GDP created by the State sector-which, thanks to the quirks of India's national income accounting system, simply amounts to the wage-bill of government employees-will come crashing down this year. Don't forget, the implementation of the Fifth Pay Commission's recommendations in 1997-98 swelled the GOI's wage-bill by an additional Rs 12,000 crore. Now that this bulge has been absorbed by the system, the growth-rate of central administration will drop from 12 to 3 per cent this year.

With wage-growth braking, consumption-growth will also slow down. Which is bound to dampen demand growth. Private consumption expenditure is projected to grow by just 5.60 per cent this year as compared to 7 per cent in 1998-99. So, although 2 components of aggregate demand (investment and net exports) will grow faster than last year, the crucial third component (consumption) will decelerate. Still, on balance, the growth in aggregate demand should be marginally higher than last year, which is reflected in the additional 0.20 per cent growth in GDP forecast for 1999-2000.

THE METHODOLOGY

Economic models are of 2 varieties. Computable general equilibrium models (large blocks of simultaneous equations) are used to generate short-run forecasts. Macro-econometric models, (which crunch time-series data to estimate structural relationships) are used for medium- to long-term forecasting.

The model used by the Development Planning Centre is a macro-econometric model. Developed 2 years ago, it employs regression-estimation techniques to create 4 inter-related blocks of equations: the Production Block, the Monetary Block, the Fiscal Block, and the External Block.

Essentially, regression-estimation techniques use past trends to calculate a correlation coefficient, which measures the intensity of the relationship between variables. When the Central Statistical Organisation (CSO) forwards the base-year for national income accounts data from 1980-81 to 1993-94, the entire model will have to be re-estimated. However, since the CSO has not yet provided the revised national income series for years before the new base-year, forecasters still have to rely on the old series data. To incorporate at least some of the revisions, the econometricians at the Development Planning Centre projected the old GDP (1980-81 series) on the basis of the new GDP (1993-94 series) growth-rates.

This model has been developed in collaboration with the Indian Planning Commission, the Netherlands Bureau for Economic Policy Analysis, and Erasmus University. The project has been funded by the Dutch Ministry of International Cooperation. All the number-crunching for this project was done by a Development Planning Centre team comprising B.B. Bhattacharya, V.P. Ohja, and M.M. Agarwal. And this analysis of the forecast was written by BT's Rukmini Parthasarathy.

This moderate pace of expansion will continue into the medium term. Assuming a normal monsoon, and no major changes in economic policy, the IEG-DPC Forecast projects that the economy will grow faster in future. By 2001-02, growth-rates will hit 6.70 per cent. Which is lower than the 7-plus per cent of the mid-1990s, but this path should not generate any macro-economic imbalances. Sure, the rise in aggregate demand will cause inflation-rates to inch up, but the climb will be modest. As per the IEG-DPC Forecast, the GDP deflator-a comprehensive measure of inflation-will climb from 7 per cent in 1998-99 to 8.40 per cent by the end of the period, which reflects an increase of 140 basis points over a period of 3 years.

THE EXTERNAL SECTOR FORECAST. The three years of the industrial slowdown coincided with three years of exports slowdown. Although they had started decelerating well before the Asian crisis convulsed the world economy, the subsequent sluggishness in world trade caused India's exports to shrivel, both in volume and value terms. In 1998-99, India shipped $34.90 billion of merchandise exports-an anaemic 1.70 per cent increase over 1997-98's $33.60 billion. Unsurprisingly, not only was 1998-99 a bad year for industry, with the Index of Industrial Production edging upwards by just 3.90 per cent, the IEG-DPC Forecast estimates that the sharp slowdown in world trade, combined with the steep fall in global commodity-prices last year, subtracted anywhere from 0.5 to 1 percentage point from GDP growth in 1998-99.

As evidence mounts that the long boom in the American economy may, finally, be drawing to a close, uncertainty over global trade prospects will persist. But the rebound in Asia will bolster flows. According to the World Bank's forecasts, world GDP growth will pick up, rising from 1.70 per cent in 1998 to 1.90 per cent in 1999. And, as the recovery gains momentum, it will cross 2.70 per cent in 2000. Even these modest rates should support an expansion in the volume of world trade by 6 per cent per annum.

Buoyed by this, the volume of India's exports will also rise. Forecast 99 projects that volumes will surge by 9.50 per cent over the forecast period-almost double the 4.80 per cent in 1998-99. Significantly, as global commodity-prices firm up, the dollar value of exports will also jump. Indeed, in dollar terms, India's exports will grow at an even-faster clip of 11.80 per cent per annum, suggesting that, by 2002, unit value realisations will improve.

In rupee terms, the gains will be greater because they will be magnified by the depreciation of the rupee. Assuming that the rupee is allowed to depreciate in line with the inflation rate differentials between India and her trading-partners, the rupee should fall by an average of 6 per cent per annum to end up at Rs 51.20 to the US dollar by 2001-02. But while depreciation, coupled with hardening commodity-prices, will boost exports, it will also swell India's import bill. Bulk imports like crude oil-which account for one-third of our total imports-tend to be price-insensitive. As the industrial recovery gathers steam, the demand for both bulk and non-bulk imports will climb. According to the IEG-DPC Forecast, the dollar value of imports will rise steadily by 11 per cent per annum over the forecast period.

As a result, India's deficit on her trade account (on a balance-of-payments basis) will widen from $15.70 billion to $20.70 billion. Worryingly, this will begin to pressurise the balance of payments. Despite the small surplus on the services account, and the steady growth in private remittances, India's current account deficit will bloat from 2.30 to 3 per cent of GDP in 2001-02. While that will still be below Asian levels, the deficit will exceed capital inflows, resulting in a drawdown of foreign exchange reserves. By 2001, our reserves will be down to 6 months of imports compared to the current 9 months.

THE INVESTMENT FORECAST. Apart from the rebound in exports, it is the pick-up in investment that will nudge the industrial revival along. During the downturn, investment-levels virtually collapsed: by 1998-99, the growth in gross fixed capital formation had slumped to 1.20 per cent. Blame, in part, interest rate rigidities for both dampening investment demand and constricting the supply of credit.

Real interest rates in India are still too high: 8 to 10 per cent as compared to the global average of around 3.50 per cent. Few projects can generate such rates of return. At the same time, saddled with high levels of non-performing assets, the banks have been reluctant to lend to corporates. Instead, money has been channelled into government securities as they offer a safe-and attractive-rate of return.

Successive monetary policies have tried to correct these distortions. Prior to the announcement of the Monetary & Credit Policy for 1999-2000, the Reserve Bank of India (RBI) cut the Cash Reserve Ratio (CRR) by 50 basis points to 10 per cent. Assuming that this reduction continues in a phased manner-100 basis points every year-the IEG-DPC Forecast predicts a decrease in both money supply expansion and interest rates. E.g., the Prime Lending Rate (PLR) will decline from 13.20 per cent in 1998-99 to 11.30 per cent by 2001-02.

Better still, the average yield on government securities will dip from 10.60 per cent in 1998-99 to 9.60 per cent in 2000-01. Since inflation rates are rising, the fall in real interest rates will be steeper, stimulating investment demand. And, since the yields on government securities are declining, the supply of credit to the private sector should rise. Consequently, by 2001-02, investment growth-rates will spurt to double-digit levels in the Indian economy.

THE FISCAL FORECAST. Movements in government revenues, usually, mirror movements in industrial production. As corporate India climbs out of the slowdown, tax-collections will also follow a rising graph. Based on 7 per cent GDP growth, Budget 99 projected growth-rates of 18 and 20 per cent for Customs and Excise revenues, respectively. Although GDP growth-rates will be substantially lower, the IEG-DPC Forecast expects indirect tax-collections to remain buoyant. Firming petroleum prices, and a sharp rise in imports will boost Customs collections by 22 per cent while a mild industrial recovery will improve the excise mop-up by 14 per cent.

Increments in government expenditure, however, will limit these gains. The 3 major components of revenue expenditure-interest payments, subsidies, and salaries-have consistently exceeded budgetary estimates. Add to that the elections-related expenses and the enhanced defence outlays that the Centre's coffers will have to bear-and the growth in non-Plan expenditure is bound to shoot past the budgeted increase of 8.60 per cent in 1999-2000.

The GOI's book of accounts will, therefore, improve only marginally: the combined deficit of the central and state governments will decline from 9 per cent of GDP in 1998-99 to 8.50 per cent in 1999-2000. In the medium term, the rise in GDP growth-rates will pare it down to an average of 7.70 per cent. However, that will not be enough to counter the squeeze on public investment.

Since 1991, the ratio of public investment to GDP has been sliding. Given the current trends in revenue and expenditure growth, the IEG-DPC Forecast does not expect any increase in this ratio. So, although falling interest rates will help boost private investment, capital formation in the public sector-notably, in the infrastructure sector-will remain limited. And GDP growth will remain capped at 6.10 per cent over the forecast period-below the scaled-down Ninth Plan target of 6.50 per cent.

Can a mix of fiscal and monetary policies boost this trajectory to double-digit levels? After all, governments across Asia are spending to reflate their economies. To examine whether monetary and fiscal policies can jumpstart growth, 3 policy-simulations were run.

The results: according to the model, none of these will produce sustainable growth. A liberal monetary policy (Option I) will boost the growth-rate by a mere 0.40 per cent at the cost of a 1 per cent hike in inflation over the baseline projections. Moreover, the big bang fiscal strategies (Options II and III) will jack up the growth-rate significantly, but will also lead to double-digit inflation. Worse, they will generate huge current account deficits as an overheating economy sucks in more imports.

Clearly, no amount of macroeconomic tinkering can lift the New Hindu Growth Trajectory of the Indian economy. Privatisation, and the rationalisation of user-charges for physical and social infrastructure are the only ways the goi can finance a much-needed increase in infrastructure investment. Similarly, for the private sector, the basic impetus for growth has to come from productivity-increases which, in turn, will involve painful restructuring. As a nation, India has, finally, run out of easy options at the end of a century. Or so the IEG-DPC Forecast 99 concludes.