An
appreciating exchange rate, stock market volatility
and global pessimism are yet to affect India’s growth
story. Figures released by the Central Statistical
Organisation at the end of August indicate that GDP
grew by 9.3 per cent during the first quarter (April-June)
of 2007-08 when compared with the corresponding quarter
of 2006-07. This is the sixth of the last seven quarters
in which the annualized rate of growth of GDP has
exceeded 9 per cent, the exception being the third
quarter of 2007 when growth fell short of that target
by just 0.3 percentage points.
The quarter-on-quarter annual GDP growth rate first
crossed the 9 per cent mark in the second quarter
of 2003-04, and has remained above that level in 10
of the 16 quarters since then. Restricting the analysis
to the current series of national income statistics
with 1999-2000 as base, we find that in the 13 quarters
prior to that (starting with the first quarter of
2000-01), the GDP growth rate never crossed the 6.7
per cent mark and stood below 5 per cent in five of
those annual comparisons. In the event, if we make
a crude comparison of averages of quarterly growth
rates for the two sub-periods starting with the first
quarter of financial year 2000-01 and the second quarter
of 2003-04 respectively, India appears to have traversed
from a rate of growth averaging 4.8 per cent to a
rate of growth of 8.8 per cent (Chart 1). In sum,
the country seems to have experienced a sudden boost
in the middle of 2003 that resulted in a more than
80 per cent increase in its average quarter-on-quarter
GDP growth rate.
Chart
1 >> Click
to Enlarge
While
celebration over this remarkable transition to a new
growth trajectory continues, convincing explanations
of this statistical trend are difficult to come by.
One route to follow to arrive at such an explanation,
however tentative, is to search for sectoral drivers
of growth in overall GDP.
There are a number of features of the sectoral composition
of growth that needs noting. To start with, the widely
held perception that the agricultural sector (broadly
defined to include forestry and fishing) has not been
part of India’s growth transition is corroborated
by the data. Agriculture has languished at a time
when the trend rate of growth has been rising. The
divergence in growth rates of overall and agricultural
GDP has persisted and even widened after the 2003
breakpoint, even though the volatility in agricultural
growth rates has fallen since then. While agriculture’s
share in aggregate GDP averaged more than 21 per cent
during this decade, its contribution to the quarter-on-quarter
absolute increase in GDP has remained below 10 per
cent in most recent quarters.
The second much-noted feature is that services seem
to have played an important part in India’s growth
story. Services GDP has grown faster than aggregate
GDP for most of the period since 2000. What is more
there appears to have been acceleration in the growth
of services GDP during the second of the two sub-periods
being discussed. In most quarters since 2003, services
have contributed between 50 and 65 per cent of the
quarter-on-quarter increment in GDP.
However, a disaggregated analysis suggests that it
is only one component of the services sector—Financing,
Insurance, Real Estate and Business Services—that
appears to have contributed to the acceleration in
GDP growth. The rate of growth of this segment of
services has been accelerating since the middle of
2002. On the other hand, the rate of growth of the
other important segment of services—Trade, Hotels,
Transport and Communications—though higher on average
in the second sub-period, has shown no signs of any
significant acceleration.
Fourth, in a less noticed development, the sector
that appears to have contributed significantly to
the growth transition is manufacturing, which has
seen a sharp acceleration in annual rates of growth
between the first and second periods. It has also
registered a significant and consistent increase in
its contribution to the annual quarter-on-quarter
increment in GDP. This less-recognized aspect of the
growth story signifies a shift away from the excessive
dependence on services to generate increases in India’s
GDP growth.
Overall, therefore, the evidence seems to suggest
that financial, real estate and business services
and manufacturing are the two sectors that have driven
India’s transition to a higher growth trajectory.
Four questions arise. What has been the relative importance
of exports and domestic demand in explaining the transition?
Is the simultaneous role of finance and manufacturing
as growth drivers coincidental or related? If related,
what is the mechanism by which their interaction translates
into higher growth? And, if this mechanism did trigger
the transition, why did it come into operation when
it did?
Export revenues have unquestionably contributed to
the expansion of the business services sector, which
includes software and IT-enabled services. But manufactured
exports have also played a significant role. The average
rate of growth of the dollar value of merchandise
exports from India rose from 13.2 per cent during
2000-01 to 2002-03 to 25 per cent during 2003-04 to
2005-06. Sectors under manufacturing that have contributed
to this recovery include Chemicals (17 to 25 per cent),
Manufacture of metals (15.2 to 31.4), Machinery and
instruments (19.7 to 33.7) and Transport equipment
(18.7 to 50.9). However, while this step up in export
growth would have has contributed to the acceleration
in manufacturing growth rates, the small share of
exports in manufacturing production still gives domestic
demand an important role in explaining the growth
recovery.
Chart
2>> Click
to Enlarge
Domestically,
the simultaneous boom in finance and real estate on
the one hand and manufacturing on the other is not
fortuitous. The financial boom is based on an increase
in liquidity in the system that has permitted a sharp
increase in credit provision and ensured a relatively
low interest rate regime. This has, in turn, triggered
a boom in the real estate sector, driven by a sharp
increase in housing finance and lending to and investment
in the real estate sector. Thus, within the Finance
and Real Estate sub-sector there are internal linkages
that deliver a rapid increase in GDP based on easy
finance.
But easy finance impacts on manufacturing too in two
ways. First, it results in a credit-financed housing
and consumption boom that significantly steps up manufacturing
demand. And, second, the profits derived from the
credit financed manufacturing boom are much higher
than would have otherwise been the case because of
much lower interest costs. Higher profits in manufacturing
trigger, in turn, an investment-led boom in that sector.
Thus, the Indian economy’s sudden transition in mid-2003
to a higher growth trajectory, while influenced by
a revival in exports, was driven in the final analysis
by a financial boom that eased credit availability,
reduced interest rates and encouraged debt-financed
consumption and investment. But why did this financial
spur occur when it did? The timing was influenced
by factors external to the Indian economy that resulted
in a surge in inflows of foreign capital into developing
countries since around 2003. India benefited disproportionately
from those flows both because of her liberalised investment
environment, relatively good economic performance
and also because of the concessions offered to foreign
investors in India, including the abolition of the
long-term capital gains tax in the Budget for 2003-04.
The liquidity overhang that the surge in capital flows
resulted in created the environment that facilitated
the growth transition.
However, this role of capital inflows in placing India
on a new growth trajectory also make that growth process
fragile for reasons that are becoming clear in recent
months. One source of such fragility is the continued
appreciation of the exchange rate of the rupee despite
the efforts of the Reserve Bank of India to stall
such appreciation. Signs are that rupee appreciation
is reducing the competitiveness of India’s exports
and weakening the export stimulus that contributed
to an improvement in both services and manufacturing
growth.
The other potential source of fragility is the threat
of a liquidity crunch because of an outflow of foreign
capital for reasons unrelated to India’s economic
performance. Dependence on foreign capital flows has
made India vulnerable to the contagion effects of
financial crises elsewhere, such as the sub-prime
crisis in the US. One consequence of that crisis has
been a tendency for foreign investors to sell out
assets acquired in India and repatriate the receipts
so as to cover losses and meet commitments in the
US and elsewhere. That prospect is resulting in a
degree of uncertainty in India’s real estate market
where foreign investors have been important players
in recent times. Their exit could slow or stall the
expansion of real estate sector. The exit of foreign
investors could also absorb much of the liquidity
in the system, adversely affecting credit availability
in the Indian market and pushing up interest rates.
If that happens the spur to growth provided by easy
finance would also be weakened, slowing growth. These
tendencies, though visible, have yet to substantially
slow India’s rapid growth. But if they gather strength
the impact on growth could be adverse. This is the
inevitable outcome of India’s indirect dependence
on foreign capital inflows to ensure its transition
to a new growth trajectory.
