Volume IV Issue 1
May 12, 2004

I received an interesting report 'India Outlook 2004-05' prepared by
Asian Development Bank.

Quote

The medium-term economic growth outlook is buoyant. The economy is on
the upswing of a business cycle, which is in turn riding on an
accelerating long-term growth path. The high growth momentum is
likely to be sustained through FY2004-FY2005. This forecast is based
on the assumption that sound macroeconomic fundamentals will be
maintained, including the expected initiation of a serious fiscal
consolidation effort following elections in May 2004; that business
sentiment will continue to strengthen inside and outside the country;
and that there will be normal monsoons during the period. Based on
these positive assumptions, GDP is forecast to grow at 7.4% in 2004,
with trend growth of 3.0% and 8.0% in agriculture and services,
respectively, and 10.2% in industry, which reflects a peaking of the
industrial business cycle that started in FY2002, prior to the upturn
of the GDP business cycle. Despite the downturn of the industrial
cycle in FY2005, higher services growth of 9.0% is expected to lead
to aggregate growth of 7.6%. In terms of the contribution to growth
of different components of aggregate demand, consumption growth has
the largest estimated share of 52.2% during FY2004-FY2005, followed
by 36.3% for investment, 9.5% for government consumption, and 2.0%
for net exports. However, over 80% of the change in consumption
demand is itself endogenously derived from income growth. Thus,
analytically it is the contribution of investment growth that must be
regarded as the leading determinant of the rate of GDP growth.

The positive assumptions underlying the projections above have
associated risks. If the new Government that takes over in May 2004
fails to come to grips with the fiscal deficit and other urgent
reform issues, this will erode business confidence and undermine
investment, resulting in reduced growth. A shift in international
investor preferences could curb or even reverse the inflow of foreign
capital since much of the current capital inflows are easily
reversible. This calls for a cautious policy with regard to capital
account liberalization. Finally, a setback in agriculture due to poor
monsoons could be damaging for growth, and especially for employment
and poverty reduction.

Of all these risks, the link between fiscal consolidation,
investment, and growth is particularly important. The private sector
savings rate is about 26% of GDP, while the private sector investment
rate is only around 16%. Thus, over 10% of GDP or 38.5% of private
savings is appropriated for the public sector. However, since there
is a dissaving of about 2.0% of GDP in the public sector, and a small
current account surplus, the investment rate has remained at around
23-24%. The 10th Plan growth target of 8.0% assumes an increase in
the investment rate to 28.4% of GDP and a public investment rate of
8.4% of GDP, including financing by public savings of about 0.44% of
GDP. These targets and assumptions are unrealistic, since even this
modest public sector surplus implies a sharp fiscal turnaround from
the dissaving at present. However, assuming that the new Government
will launch a serious fiscal consolidation effort and achieve some
reduction in public dissaving, the overall savings rate is expected
to rise to 24.8% and 25.3% of GDP in FY2004 and FY2005, respectively.
The investment rate is projected at 24.5% and 25.0% of GDP during
these 2 years, allowing for a small current account surplus of 0.3%
of GDP.

Taking advantage of declining interest rates abroad and the large
inflow of foreign capital, India has been prepaying some of its high-
cost external debt. This process is likely to continue over the
medium term, reducing the external debt ratio from about 18.0% in
FY2003 to around 16.0% in FY2004 and further to 15.0% in FY2005. Debt
prepayment has also moderated the appreciation of the exchange rate
and the impact of capital inflows on the monetary base. The central
bank is expected to continue the policy of sterilization within an
accommodative monetary policy stance. Accordingly, money supply
growth is likely to remain in the range of 13.5-13.6% over the
forecast period, and inflation will remain moderate at 4.7-5.0%.

Per capita income will be rising through FY2004 and FY2005 because of
GDP growth well in excess of low and stable population growth,
leading to a decline in the poverty ratio, though its pace will
depend on employment growth, especially in the agriculture sector.
Even then, the poverty-reducing impact of agricultural growth is
expected to be weak
because of low employment growth in the sector.

An alternative route to employment growth is through progressive
transfer of the work force from agriculture to industry and services.
Unfortunately, expansion of the modern services sector has created
mainly high-skill, high-productivity jobs rather than mass
employment. The observed higher growth of employment in the industry
sector is more
promising. The employment share of industry, only around 17% at
present, will rise if the recent strong growth of industry can be
sustained through high investment. More important, with continuing
high public investment in transport and communications
infrastructure, as the rural and the urban economies become better
integrated, this will give an impetus to the growth of industry and
services in rural areas. This should in turn lead to rapid growth of
rural off-farm employment, rising rural incomes, and further
generation of rural employment.

However, the development of this virtuous cycle is a long-term
process. Hence it would be unrealistic to expect a major improvement
in employment growth or poverty reduction in the medium term. The
same applies to the Millennium Development Goals (MDGs), where
India's performance has been mixed. While some targets, such as
enrollment for primary education and access to improved water
sources, are on track, others, such as female secondary enrollment
and reduction in infant mortality, are lagging. The 10th Plan set up
its own monitoring targets, which are more demanding than the MDGs,
and also called for an 80% increase in social sector spending to
speed up social development.

The accomplishment of these goals will depend both on successful
fiscal consolidation and on improvements in governance to ensure
better delivery of education and health services. Thus, dramatic
improvements within the next couple of years are unlikely. However,
social indicators are improving, albeit gradually, and the MDGs for
2015 are certainly achievable if the required reforms are pursued
with determination.

Unquote

Courtesy HDFC AMC Ltd

S.Rajagopal
Owner & Moderator
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