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Journalism of Courage
It is good to ask, this last week of the year, a year which has almost made 8 per cent growth passe, where is economic punditry headed next year? Specifically, are we taking over to 2007 the wisdom that 2006 is when the economy started overheating?
There has been good news on growth, if one ignores October8217;s industrial production and export figures. The Central Statistical Organisation CSO started reporting quarterly GDP figures from 1996-97 and, since then, the 9.2 per cent in Q2 of 2006-07 is one of the highest quarterly growth figures. This brings growth in the first half of 2006-07 to 9.1 per cent and the full financial year is certain to show 9 per cent-plus. We will thus have four successive years of 8 per cent plus, vindicating the proposition that we have broken away from a trend of 6.5 per cent. Five Year Plans have been notorious in never being able to achieve targets. But the 11th Five Year Plan8217;s 9 per cent, later accelerating to 10 per cent now seems conservative. The annual rate of population growth is around 1.6 per cent now and 9 per cent growth means per capita income growth of 7.4 per cent, implying an unprecedented growth in consumption and prosperity, notwithstanding the problem that this is not being evenly spread across various divides, from geographic to gender-related ones.
But caveats are in order. Agriculture doesn8217;t employ 72 per cent of the population. The figure is more like 54 per cent. There is a difference between 8216;agriculture8217; and 8216;rural8217;. No one can expect agriculture to grow at 4 per cent. When government pronouncements talk about agriculture growing at 4 per cent, they really mean agriculture and allied activities. Incidentally, agriculture and allied activities now only account for 17.2 per cent of GDP. Finally, Q2 is always bad for agriculture and the 1.7 per cent figure is for food grain output, not all agriculture, and certainly not for agriculture and allied activities.
Fourth, people will argue such growth rates are unsustainable, citing infrastructure. Infrastructure is in a mess, although roads and railways have improved. But I don8217;t think the infrastructure mess is a binding constraint at 9 per cent, although it might become one at 11 per cent. Fifth, points will be made about inflation. How much is inflation? The answer is linked to the price index used and basket of commodities and their weights in the index. Last Friday8217;s wholesale price index WPI data showed a point-to-point inflation rate of 5.12 per cent. There was some excitement when for the week ending 18th November, the WPI showed a point-to-point inflation rate of 5.45 per cent higher than previous week8217;s 5.29 per cent and driven by price increases in both manufactured and agro pulses products. At 5.45 per cent, inflation was about to cross RBI8217;s desired upper bound of 5.5 per cent; no one takes the North Block target of 4 per cent seriously. Unlike WPI, if it is the consumer price index CPI one uses, we have more than one series and CPI-based inflation is close to 7 per cent. Once seasonality in agro price increases is over and reductions in petroleum product prices are factored in, both WPI- and CPI-based inflation should drop. Therefore, one shouldn8217;t press panic buttons, jack up interest rates and squeeze both consumption and investment expenditure. But given UPA government8217;s proclivities and RBI8217;s cautiousness, that8217;s precisely what is likely to happen in January, with an increase in interest rates by 0.5 per cent by March. The increase in credit growth, far outstripping increase in deposit growth, will be cited. An argument will be made that there is plenty of liquidity in the system and even if RBI hikes rates, that shouldn8217;t lead to general interest rate increases.
We already have signs of such reaction, with the cash reserve ratio increased to 5.50 per cent and hikes in repo and reverse repo rates. And there we come to the argument about overheating. In economics, over-heating means excess demand, because productive capacity cannot keep up with demand and there is demand-pull inflation. The trend rate of growth is then unsustainable and must be slowed, perhaps with central bank intervention. Note, if it is agro price increases we are concerned with, lack of supply-side responses has more to do with non-reforms in rural and agro sectors, apart from messing up trade policy. Liquidity and interest rates are irrelevant.
One may think there is a limited case for overheating if one has manufactured products in mind. But there too, new capacity is being set up and price increases should be transient. The case for overheating is therefore not proven. Unfortunately, knee-jerk reactions are inevitable. And for the first time, we will witness an under-heated economy slowed down through central bank intervention. The slowdown in exports and manufacturing growth witnessed in October is the beginning. Growth, investment sentiments and the capital market will all suffer.
The writer is an eminent economist
