Growth momentum - Strength & Resilience Can Overcome Obstacles

SS Kothari
The Statesman, 11 December

The Indian economy has entered a high growth trajectory which ought to be sustained. India has the potential of becoming a developed nation by the middle of this century, if not earlier. The growth in GDP in 2006-07 has been 9.4 per cent ~ one of the highest in the world. Investment in the year has risen to 35.1 per cent, while savings have increased to 34.7 per cent. What is significant is that the savings and investment ratios are moving towards alignment with those in East Asian “miracle countries” ~ Malaysia, Singapore et al.

While moving in the high growth trajectory, difficulties will have to be overcome. Consider the present situation. The RBI has increased the cash reserve ratio (CRR) to 7.5 per cent from 7 per cent, impounding about Rs 16,000 crore particularly to manage excess liquidity in the economy consequent upon massive capital inflows. The status quo in respect of the bank rate and repo rates has been maintained. Although wholesale price inflation has been reduced from 6.4 per cent in April 2006 to 3.1 per cent in mid-October this year, RBI is concerned over high food prices and volatile international oil prices.

Money supply

Money supply at 21.8 per cent is above the RBI’s target of 17.5 per cent; the acceleration is due to fiscal spending and exchange market interventions. The partial impact of the international prices of crude oil and food, which could accentuate consumer prices, is indicative of suppressed inflation which has a disturbing potential for the future.

There have been massive inflows of FII and FDI and the Reserve Bank had to resort to intervention to check the rise in liquidity and increase in the value of the rupee. With effect from August 2007, it had increased the CRR to 7 per cent. CRR deposits do not bear any interest. The value of the rupee increased substantially from Rs 46 per dollar in July 2006 to presently below Rs 40 per dollar. These measures reduced liquidity, but not to the desired extent.

The effect of these measures however resulted in a sizeable increase in the interest rate structure. And they have impacted the growth rate to some extent. Industrial production which increased by about 11.1 per cent in the first half of 2006-07 came down to 9.2 per cent in the first half of the current year. During the same period, the growth of the manufacturing sector declined from 12.3 per cent to 9.7 per cent.

Industrial production during September 2007 declined to 6.4 per cent as compared to 12 per cent in September 2006. Manufacturing growth was reduced to 6.6 per cent against 12.7 per cent in September last year. This has been attributed to deceleration in consumer demand largely due to high interest rates.

Not only consumer durables, but the growth of infrastructure industries also declined during the half year 2007-08 to 6.6 per cent from 8.7 per cent in the corresponding period in 2006-07: crude petroleum 0.7 per cent (4.1 per cent last year); petroleum refinery sector 9.8 per cent (12.3 per cent); steel 6.6 per cent (12.2 per cent) and cement 8.3 per cent (10.6 per cent). This was principally due to a sharp decline in infrastructure growth to 6 per cent in September 2007 as compared to 10.6 per cent in September last year.

Actually there has been a decline in bank credit from 33 per cent in June 2006 to 23 per cent in August 2007. It is felt that higher interest rates on working capital and other loans by banks to industry were adversely affecting profitability, cost of industrial expansion and investment. High interest rates, with US Federal rate cut, provide a stimulant to further capital inflows.

The RBI has a dual perspective: of price stabilisation as also sustaining the momentum of growth. Monetary policy and fiscal policy should be integrated by the government and RBI. This will ensure that the growth trajectory of the economy is not hampered. If the momentum decelerates, it would be difficult to regain it.


RBI has a distinguished record of insulating the economy against international crises. The Indian economy was not affected by the 1997 East Asian meltdown. As regards inflation, the wholesale price index is around 3 per cent, which is quite below the RBI’s target of 4-4.5 per cent. Regarding the consumer price index, the prices of food articles have to be brought down more by supply side measures. Monetary measures are not likely to have much of an impact.

International prices of crude oil are unconscionably high exceeding $90 a barrel. Three measures are recommended for the domestic sector: the issue of bonds to oil companies; some increase in the domestic prices of petrol and diesel; and reduction in excise and other taxes which constitute a sizeable portion of prices.

The value of the rupee may be allowed to rise to around Rs 38 per dollar. This reduces the total cost of oil imports and prices of intermediates and the capital goods for industry. The interest rate structure should be brought down by RBI in the interest of sustaining the momentum of growth. Taking a slightly longer term view, the finance minister is optimistic that both industry and services could reach a growth rate close to 10 per cent for 2007-08. This implies that 83 per cent of the economy is growing at the rate of 9 to 10 per cent.

The International Monetary Fund has cautioned against measures to decelerate capital inflows. FDI inflows should be welcomed. The Planning Commission, in the context of formulating the 11th Plan, is also in favour of relaxing FDI norms in key sectors like insurance, private banking, broadcasting, defence production, print and electronic media, as also air transport, asset reconstruction firms and cable networks. This would stimulate transfer of technology which is critical for improving competitiveness.

Critical elements

The plan will also urge the government to consolidate gains from FDI by reducing delays in state level clearances. Growth should also be made more inclusive by effective monitoring of poverty alleviation programmes at the national and state levels. As regards FIIs, SEBI has rightly imposed restrictions on fresh investments through participatory notes (PNs) and directed that derivatives-based PNs should be wound up in 18 months. SEBI is also modulating the broad direction on three critical elements ~ access, products and disclosure of investor’s identity so as to allow entry of “good money” only. Anti-money laundering guidelines will be an important element in the formulation of a disciplinary code for FIIs. Thus with regard to registering new FII’s, their credentials and creditworthiness should be scrutinised and easy accessibility to markets restrained. In any case, SEBI is the best judge on how to regulate and modulate FII inflows.

The Indian economy has acquired considerable strength and resilience and it has the ability to overcome obstacles to growth.

The writer is a former member of the Lok Sabha