The growth euphoria is over

The 12th Plan, which will be in operation from 2012-13 to 2016-17, will come up before the National Development Council today.

However, the draft Plan document was recently placed on the Web site of the Planning Commission. It comes in three volumes, running into 1000-odd pages.

The Chapter on Macroeconomic Framework in the first volume outlines three growth scenarios for the next five years.

Growth Scenario

The first scenario is ‘strong inclusive growth’ in which growth could average 8.2 per cent.

The second scenario considers ‘insufficient policy action’ where broad direction of policy is pro-growth but implementation of the required reforms is tardy. In this scenario growth could slip to somewhere between 6-6.5 per cent.

The third scenario is ‘policy logjam’ characterised by a lackadaisical approach to economic policy, supply constraints and erosion of investor confidence.

In such a situation, growth can drift downwards to 5-5.5 per cent. Incidentally, the Indian economy at present is posting a growth rate suggested by the policy logjam scenario.

In the best case scenario, growth of agricultural and industrial output is projected to increase to 4 per cent and 8.1 per cent, respectively, and that of services will moderate to 9.1 per cent per annum.

From a reading of the Macroeconomic Framework for the 12th Plan, three key challenges emerge. They are in the realm of resource use efficiency in the system, government finances and external payments.

Resource Use Efficiency

Efficiency in resource use captured through the ICOR (incremental capital output ratio) deteriorated significantly during the 11th Plan. Compared to an ICOR of 4.1 for the 10th Plan, the 11th Plan achieved an ICOR of 4.5, indicating erosion in resource use efficiency. The 12th Plan does not explicitly mention the likely ICOR. However, the ICOR can be derived implicitly from the ratio of fixed investment plus stocks as per cent of GDP to the growth rate. The 12th Plan projects an average fixed investment rate of 34 per cent and stocks at 3.5 per cent of GDP.

The projected investments juxtaposed with the projected growth rate in the best case scenario yields an ICOR of 4.6 for the 12th Plan. Thus, the macroeconomic framework suggests a further deterioration in resource use efficiency in the 12th Plan even in the best case scenario.

Resource use efficiency may deteriorate significantly in the policy logjam scenario. It is perhaps due to these worsening numbers that the Plan document has avoided any discussion on resource use efficiency in the system. Nonetheless, improving the resource use efficiency is going to be a key challenge.

Fiscal Stress

The fiscal scenario worsened during the 11th Plan period as the combined fiscal deficit of the Centre and States increased from 3.97 per cent in 2007-08 to 8.10 per cent in 2011-12. Central government revenues as a proportion of GDP declined by 2 percentage points during the 11th Plan.

The fiscal concessions doled out to tackle the slowdown arising from the global financial crisis were partly responsible for the deterioration in public finances. The lack of political consensus on implementing tax reform measures, such as the GST and reduction of subsidies, have also contributed to the fiscal mess. The Prime Minister had resolved to ‘bite the bullet’ in cutting subsidies. The progress in improving government finances, however, has been tardy. The problem on the fiscal front can be managed if growth revives to 8 per cent or thereabouts.

External Payments

India’s external account is characterised by higher imports and lower exports. This structural mismatch between imports and exports is reflected in the current account deficit (CAD).

India’s CAD averaged 2.7 per cent during the 11th Plan, higher than the sustainable 2.5 per cent. It is projected to slip further to 2.9 per cent of the GDP during the 12th Plan.

Total net capital flows amounted to 4.1 per cent of GDP during the 11th Plan. However, non-debt creating inflows were only 2.1 per cent and the rest was in the form of different types of loans, including ECBs and NRI deposits. Given the structural imbalance on the current account, ensuring stable source of financing the deficit is going to be a key challenge in the 12th Plan.

Net FDI and FII flows are projected to decline to 1.5 per cent of GDP during the 12th Plan. Inward FDI, which averaged 2.2 per cent for the 11th Plan, is projected to decline to 1.8 per cent of GDP during the 12th Plan. Equity flows are projected to fall more sharply from 1.3 per cent of GDP to only 0.5 per cent of GDP.

The Plan document acknowledges having taken a conservative view of the global risk appetite and perception of India as an investment destination.

The document, in keeping with its conservative approach, points out that if growth momentum picks up 2013-14, it may lead to FII flows at an average of 1 per cent of GDP in the Plan period.

With central banks of developed countries pursuing an ultra-expansionary monetary policy, a part of the additional liquidity will find its way to the emerging market economies, which generate better returns. We can expect better performance on the FDI and FII front if the domestic growth constraints are sorted out.

A fourth key macroeconomic challenge that the Indian economy faces in the short-to-medium term is putting a lid on the supply-led price pressure observed in the past three years.

The Plan document has maintained a stoic silence on inflation. Sharing perspectives about inflation in a macroeconomic framework would have helped the Reserve Bank of India tune its policy.

Addressing investor confidence, both domestic and foreign, through growth-supporting policies will be the key to achieving sustainable growth in the 12th Plan.

(The author is Associate Dean, Xavier Institute of Management, Bhubaneswar. The views are personal.)