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The five-year growth chase

Subir Gokarn

When it comes down to it, the arithmetic of economic growth is much like the arithmetic of one-day cricket.

If you are chasing a target, be it gross domestic product growth for five years or runs for 50 overs, the performance in every year (or over) will affect the target in the period remaining.

If you do better than required in the early part of the innings, the pressure in the later part correspondingly reduces.

The Government of India has just finalised the Tenth Five-Year Plan, which runs from 2002 to 2007. We are already in the first year of the Plan, which, as is pretty well known by now, sets a target of 8 per cent GDP growth per year over its five years.

In this first year of the Plan, the consensus forecast seems to lie in the range of 5-5.5 per cent, with some reputed prognosticators going below 5 per cent.

The first quarter (April-June) growth numbers, which were released a couple of weeks ago, had GDP growing at 6 per cent.

The subsequent quarters are unlikely to top that. Let's assume that growth during 2002-03, the first year of the Tenth Plan, will be 5.5 per cent.

The arithmetic of growth rates tells us that if GDP were to grow for five successive years at 8 per cent per year, it would be about 47 per cent higher at the end of the period compared to the beginning (in this case, the beginning of 2002-03).

If growth in the first year is 5.5 per cent, and we still want to end up 47 per cent higher at the end of five years, the asking rate over the next four years goes up to about 8.6 per cent.

Suppose now that for some reason, the second year's (2003-04) growth performance showed a marginal improvement to 6 per cent. In that case, the asking rate for the next three years would go up to about 9.5 per cent. As things stand today, this is very clearly in the domain of fantasy.

But, let's put aside the growth numbers for a moment and simply accept the dire need for significant acceleration.

What are the macroeconomic foundations for generating this burst of economic speed? The Plan envisages this as coming from a combination of more resources and improved efficiency.

With respect to the first source, Gross Capital Formation, reflecting the amount of its total output that an economy ploughs back to create productive capacity, is expected to increase from an average of 24.2 per cent per year during the Ninth Plan period to 28.4 per cent during the Tenth Plan.

With respect to the improved efficiency, the Plan expects that the economy-wide Incremental Capital Output Ratio, which reflects the efficiency of investment in terms of the amount of investment needed to generate an additional unit of output, will go down from 4.53 during the Ninth Plan to 3.58 during the current one.

This is tantamount to an efficiency gain of over 20 per cent.

One of the major criticisms of the government's management of the economy during the 1990s is based on declining public capital expenditure.

Clearly, the assumption that government withdrawal from investment activity would be compensated for by increased private entry proved to be misplaced.

At least some of the slowdown in private investment during the latter half of the 1990s is attributable to the attrition in public investment.

Crumbling infrastructure, which resulted from the government's cutbacks, does not make for a healthy investment climate. Does the Tenth Plan address this issue?

In terms of the gross numbers, public investment is expected to increase from an average of 3.5 per cent of GDP during the Ninth Plan to 4.6 per cent over the next five years.

In comparison, private corporate sector investment is expected to increase from 8.9 per cent of GDP during the Ninth Plan to 10.4 per cent during the Tenth.

The remaining comes from the household sector, which includes both residential construction and informal sector activity, whose investment goes up from 8.2 per cent during the Ninth Plan to 9.6 per cent in the Tenth.

The higher share of public investment, in combination with better utilisation of funds is of critical importance in increasing the likelihood of a sharp acceleration in GDP growth.

But there is still the question of whether it is enough to not only eliminate the existing bottlenecks in the economy's infrastructure but also accommodate future growth in demand.

Where does the money to finance this broad-based expansion in investment come from? From the public investment perspective, divestment proceeds are expected to play a big part.

Rs 78,000 crore (Rs 780 billion) are anticipated over the course of the Plan, implying annual targets of Rs 15,600 crore (Rs 156 billion).

This year, the budgetary target was Rs 12,000 crore (Rs 120 billion), consistent with the Plan estimates. It is pretty clear by now that this will not be achieved, but, at least until controversy about the oil companies, there was momentum and the target looked realistic.

Even now, this will end up as a good year for divestment.

The question is: once the cream has been disposed off with reasonably good valuations, what is the government going to do with the dogs?

Significant latitude will have to be given to the acquirers to keep valuations attractive and push towards this rather ambitious target.

Foreign direct investment is another critical component of the expanded resource base.

The Plan apparently visualises an annual inflow of $7.5 billion, a sharp jump from today's levels of around $4 billion, more so because a lot of the recent surge is due to acquisitions of existing assets rather than the creation of fresh capacity.

From the growth perspective, it is only the latter that counts.

Finally, in a situation in which the desirability and efficacy of the reform roadmap is being increasingly questioned, it is fitting that the plan document itself endorses the unfinished reform agenda as being critical to accelerating growth.

The six point strategy, encompassing labour, infrastructure, expenditure and subsidy reforms, widening the tax base and giving more economic powers to the states are all music to the ears of the protagonists of reform.

I am clearly caught in a dilemma when I attempt to evaluate the approach to the next five years. On the one hand, the arithmetic of the growth rates leaves me rather incredulous.

On the other, when I look at the underlying macroeconomics, I see a consistent and coherent blueprint, aimed at both improving the investment climate and redressing the recent imbalance between the private and public sectors.

In the tussle between ends and means, my conclusion is this. Forget about the growth rates. Let's concentrate on doing the right things and doing them right. Growth will take care of itself.

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