Landmines to clear on the 9 percent growth path
V. Shunmugam[1]
Dalal Street Investment Journal June 2009

Economic growth as revealed by the recently released GDP numbers for 2008-09 came as a surprise to economic pundits and financial analysts alike. While important international organizations such as the International Monetary Fund and the World Bank that are monitoring the health of the economy on all its parameters predicted a grim growth rate of 4-5 percent, between them, for the Indian economy during 2008-09, the economy seemed to have come out unscathed with an estimated growth of 6.7 percent, according to the recent economic data release. It is, therefore, critical to look at what made this difference. To top it all, much to our joy, the prime minister recently assured that the economy would take the 9 percent growth path with a call for greater public spending in infrastructure. Accordingly, the markets reacted too.
What made most of the difference in the last year’s balance sheet of the economy is that the government spending alone increased by 20 percent during 2008-09 compared with the previous estimates. While a major chunk of it would have gone into offsetting the high global energy prices, the rest is estimated to have gone into formation of capital assets, as reflected in strong growth in capital formation. While one would have insulated the individuals and businesses from the oil market volatility that existed during 2008-09, the other is essential for long-term sustainability of the growth momentum in the economy. However, the fact that increased government spending came on the back of a higher estimated fiscal deficit (6.2 percent) would make the individuals and businesses a worried lot, as it would be collected from them along with interest costs in future. The moot question: will there be enough collective ability among the stakeholders to pay it back when it is due?
The past experience of deficit-driven growth suggests that the current level of deficit in percentage terms to GDP is not abnormal in our economic growth path. International examples also suggest that this level is much prevalent in a moderately aggressive growth-oriented economy. Also, our systematic repayment of the historically high external and internal debts while managing the cyclical movement of the economy in the past indicates that it is not something to be seriously worried about given the positive side it generates for investor sentiment; the need of the hour for keeping alive the growth momentum. The situation of the government in this case is much the same as that of an individual who yearns to own a home for his physical and financial security by leveraging 20 years of his future income. Of course, bankers know that not in all cases such loans go bad, given the strong risk management principles they adopt.
With the economy expected to pick up the growth momentum, not many jobs lost in the past during the meltdown years would be created in the near future, income of private individuals would remain flat in most cases, and the role of increased government spending vis-à-vis private spending assumes greater prominence. However, it is also critical to see the source of such expenditure that the government can make: as in this case, the revenue from perpetual source of taxes would in all probability shrink slightly or remain the same despite the buoyancy reported in the first two months of this fiscal year. Hence, it would become obligatory on the part of the government to reduce unproductive expenditure (including subsidies) and administration costs; seek additional sources of revenue such as sales of assets and stakes in the public sector; increase the cost of public services, and so on. While it is important to augment the sources of revenue, it is equally important that increased expenditure is parked prudently on such avenues that would strike a balance between short-term and long-term gains. The physical and social infrastructure typically stands for short-term and long-term gains to the economy. A neglect of one can only happen at the long-term cost to the other.
Although these appear to be logical economic solutions to help the new government in achieving its target growth rate of 9 percent for the current fiscal year, it would be interesting to see how the political cost of it unfolds.

[1] Author is Chief Economist with Multi Commodity Exchange of India Ltd., Mumbai. Views are personal.