The Real State of the Real Economy, According to the RBI

One of the unfortunate tendencies that developed among many official publications brought out by the economic Ministries of the Government of India over the 1990s, was the tendency to paint a rosy picture of the economy, and especially of the effects of the liberalising "economic reform" process. This tendency extended to underplaying glaring problems such as inadequate employment generation, and selectively presenting data and choosing time periods to establish more positive trends even when they did not really exist.
 
Apart from the "public relations" implications, it is not clear what advantages there were of such a tendency, even for the Government itself. After all, effective policy interventions of whatever type need to be made on the basis of informed assessment, and when the actual economic reality is sought to be disguised or incompletely described this makes the task of policy makers even more difficult. This tendency did not just make publications like the Finance Ministry's annual "Economic Survey" much less useful, it also contributed to reducing the credibility of official publications in general.
 
Fortunately, the Reserve Bank of India in recent times has shown itself to be much less influenced by this tendency. While it is true that in terms of policy prescriptions the RBI more or less sticks to the neoliberal paradigm currently prevailing in official circles, it has been more objective in its reporting at least of the basic economic reality. But this in turn makes the latest Annual Report of the RBI very depressing reading, since it describes a situation of deceleration of growth in the major productive sectors along with greater financial fragility. Furthermore, it becomes clear (although is not stated so explicitly in the Report) that this is not accidental or conjunctural, but is very much a result of the economic strategy of the past decade.
 
Chart 1 describes the growth rates (in real terms) of the major sectors in the past three years. Not only is the target rate of 7 per cent per annum far from being met, but it is evident that there is all-round deceleration especially in the last year. The RBI in fact makes a stronger statement : "Filtering the data on real GDP growth to eliminate irregular year-to-year fluctuations indicates the presence of a growth cycle in the Indian economy and a discernible downturn in the second half of the 1990s." (Summary, page 17, emphasis added.) This brings the average growth rate of the "growth cycle" over the 1990s to only 4.4 per cent, and also suggests that the process of liberalising reform has not delivered the higher rates of growth that were promised and anticipated.

Not surprisingly, these lower rates of GDP growth have also been associated with lower rates of aggregate savings and investment. Chart 2 indicates the extent of reduction in aggregate savings and investment rates even over the course of the 1990s. While the decline is not a huge one, it marks a break from the overall trend increase in savings and investment rates that is evident over the five decades since Independence, whereby these rates rose with increases in per capita income. Of course, such a decline over the past few years reflects the depressed private expectations emanating from the general slowdown in economic activity, along with the very related substantial declines in public sector savings and investment.

But there are other causes for concern in the composition of savings and investment in the recent past. It is evident from Chart 3 that private household savings of both financial and physical forms, has come to dominate savings. This includes all physical savings by non-corporate bodies, including the increase in physical assets of small-scale industries and agricultural units, and so to some extent represents a dynamism of the these sectors which must be welcomed. But to the extent that it also incorporates increase physical assets of households which are not designed to be part of productive assets (such as residential houses and passenger cars), it may in fact reflect an increase in consumption rather than saving per se. Also, the complete collapse of public sector saving, to the point where it has become a net dissaver, deserves serious attention.

These trends have their counterparts in the composition of gross domestic capital investment as described in Chart 4.  Even over the 1990s, while the share of the private corporate sector has remained the same, that of the public sector as fallen quite substantially in a relatively short time. The household sector has emerged by the end of the decade as the dominant sector in gross domestic investment.

As was evident already from Chart 1, the primary sector has experienced the sharpest deceleration in growth terms in recent years. This is part of a longer term tendency which has meant that there has been a very significant deceleration in the average annual growth rate of the all-crop index of agricultural production from 5.2 per cent in the 1980s to only 2.3 per cent in the 1990s.
 
Further, the RBI notes that during the second half of the 1990s the volatility of agricultural production has increased. The high volatility is clear from Chart 5, and is quite sharp for both foodgrain and non-foodgrain crops. The poor performance of agriculture is attributed by the RBI to "low and variable growth of output, poor and declining yields, inadequacy of capital formation and infrastructure and degradation of natural resources due to inefficient cropping patterns (which) have emerged as the major obstacles to rapid and sustained growth." (Summary, page 2)

However, the factors which are in turn behind these agricultural trends are not adequately captured by the RBI report. These factors are very much part of the overall policy environment which characterised the 1990s. Thus, one important factor behind the drop in foodgrain output growth is the drastic decline in real public investment that has occurred in agriculture over a long period. The deceleration had started during the 1980s, but the 1990s have furthered that trend. In addition, the 1990s have witnessed a decline in other infrastructure development in the rural areas, which had increased somewhat in the earlier period. Further, the strategies of reducing subsidies on fertiliser and attempting to increase user charges on water, electricity and other farming inputs which a number of state governments have tried to implement, have also raised costs for farmers and in some cases led to reduced use of commercial inputs.
 
Of course, the most glaring problem in the food economy of India at the moment is the presence of huge excess stocks of foodgrain with the Food Corporation of India, which are now as high as 62 million tonnes, up by more than three times in just six years. These are not being effectively utilised either to reduce hunger in areas and among populations which are food deficit, or to promote public works which in turn would develop infrastructure. Chart 6 makes it clear that this is a reflection of the peculiar combination of increased procurement despite lower harvests and lower off-take by consumers from the Public Distribution System. And this too, is very much a creation of economic policies of the past few years, rather than an arbitrary process.

Thus, one important reason for the lower off-take was the decision taken in the 2000-01 Budget to increase the prices of grain available in the Public Distribution System to the so-called "economic cost" of the FCI for the Above Poverty Line (APL) population and to half that cost for the Below Poverty Line (BPL) population. This resulted in a sharp decline in sales especially in the Targeted PDS.  But, as the RBI Report points out, the expansion of buffer food stocks to 3 times the desired level has been accompanied by a decline in per capita availability of foodgrain in the economy as a whole. This fell from a high of 505.5 grams per day in 1997 to 470.4 grams in 1999 and then to 458.6 grams in 2000, indicating that the basic food security problem, far from being solved, has actually worsened.
 
Simultaneously, the economic conditions of most cultivators has deteriorated because the falling international prices of most agricultural commodities in a context of more open trade in these goods has combined with higher input prices to squeeze cultivating margins. Falling market prices have meant that more cultivators have chosen to sell to official procurement bodies, thus adding even more to the excess food stocks.
 
Throughout the liberalising reform process, it has been clear that the industrial sector is much more important for government strategy than the agricultural sector, despite the fact that most of the labour force still remains in agriculture. But even industrial growth has shown signs of not just deceleration but actual recession over the past few years. While the manufacturing recession was evident from late 1996, there were expectations of a recovery based on a slight increase in growth rates over 1999. However, as Chart 7 makes abundantly clear, these hopes of a quick recovery have been belied and the last year's industrial performance shows deceleration once again. Indeed, the quarterly data show a more worrying pattern of deceleration over each quarter in recent times, suggesting a deepening of recession.

Chart 8 indicates that capital goods and basic goods are the worst performing sectors in the recent period. This of course reflects the slowdown in investment, in turn reflecting the depressed private expectations in a context of recession and reduced public investment. But of course this is also bad news for the future prognosis for industry as a whole, which would be affected by the slowdown in these sub-sectors.

Durable consumer goods have performed the best among al the sub-sectors of manufacturing. Once again, this has been affected by very specific policies of the government such as the Pay Commission award which allowed for more purchase of such goods by a segment of public sector employees, and the special protection afforded to the automobile industry in the face of wider import liberalisation for a range of final consumer goods. Non-durable consumer goods, which include many items of mass consumption, have been growing very slowly throughout this period, reflecting the very limited expansion of a mass market through the liberalisation process.
 
In this context, it comes as no great surprise to note, from Chart 9, that the infrastructure industries have also performed relatively poorly. To a large extent this reflects the inadequacy of public investment and maintenance over this period, but the slowdown in growth of effective demand has also played a role. In addition to a low average rate of growth, most of these sectors have displayed very high volatility and fluctuation in growth rates even over a relatively short time period.

The government's obsession with fiscal correction is well known, even though its declared intentions have tended to be far more draconian and "fiscally disciplined" than its actual fiscal performance. The 1990s were marked by frequent references to the need to rein in the fiscal deficit as the major, even primary, goal of the government. Of course such an obsession was problematic at several levels, not least of which was the tendency to conflate the capital expenditure part of the fiscal deficit (which implied important public infrastructure spending which could be crucial for future growth) with the revenue deficits which reflected the excess of current spending over current receipts.
 
But the concern with controlling the large fiscal deficit becomes completely ridiculous in a period of economic recession, which is also characterised by large and growing foreign exchange reserves and large and growing public holding of food stocks. It would be difficult for anyone to argue that a more aggressive fiscal stance would be inflationary in such a context, and hard to deny that this would play a positive role in moving the economy out of recession. But this, nevertheless, is what the government continues to maintain : that the need of the hour is continued or even greater fiscal rectitude, regardless of the cost in terms of reduced levels of economic activity
 
What is interesting to note is that, despite all this emphasis on fiscal discipline, the 1990s showed very little tendency towards fiscal correction overall. Chart 10 shows the fiscal and revenue deficits as shares of GDP over the 1990s, divided into three sub-periods. The fiscal deficit here is calculated according to the new definition adopted by the Central Government since the 1999-2000 Budget, that is, excluding the share of small savings that go to the State Governments.

The first sub-period is of course inflated by the effect of the crisis year 1990-91, when the fiscal deficit was as high as 6.6 per cent of GDP. Nevertheless, it turns out that the first sub-period shows an average level of fiscal deficit to GDP ratio (at 5.4 per cent) that is only marginally higher than the latest sub-period, when the average was 5.1 per cent of GDP. And what is worse, this was dominantly in the form of the revenue deficit, which climbed to the very high levels of 3.5 per cent of GDP for the period 1997-98 to 2000-01.
 
The counterpart of this, of course, was the collapse in capital expenditure which has already been noted. Central Government capital expenditure, shown in Chart 11, declined to only 1.15 per cent of GDP, not just well below the levels at the beginning of the decade, but many multiples less than the rate of 4 per cent achieved in the 1980s. And developmental expenditure of the Central Government, which also includes the items described as "social expenditure" also fell continuously over the 1990s, to levels of less than 7 per cent for the last years of the decade.

If the fiscal deficit has remained "high" despite such falling public expenditure of the socially desirable variety, it is largely because interest payments constitute a growing and dominant part of expenditure, accounting for nearly half of current revenues. And this in turn is not because of the burden of past debt alone, but more importantly because of financial liberalisation measures which have forced the government to take greater recourse to open market borrowings and raised the cost of financing the deficit. Chart 12 shows how the share of the fiscal deficit being financed by market borrowing has ballooned from less than 18 per cent at the beginning of the decade to nearly 70 per cent by the year 2000-01. This nit only means that less of government expenditure has positive linkage and multiplier effects which could generate more economic activity, but it also and naturally makes the task of actual fiscal correction that much more difficult.

Of course, the RBI document must inevitably be more concerned with monetary policy and financial issues than with the real economy, and most of the Annual Report is indeed devoted to these matters. But because it has been quite frank and realistic about the nature of the problems confronting the real economy, it provides more valuable insights than most official publications that are actually concerned with describing the real economy. And the picture that it presents is one that calls for an urgent and thorough reconsideration of the current economic strategy.