Investors move towards countries which grow at a respectable rate and which enjoy a reasonable economic and political stability. I would like to argue that despite low growth in the last two years, India’s growth potential remains intact.
As I look ahead, 2013-14 may turn out to be better. We have estimated the growth rate for the year at 6.4 per cent, even though there are others who have estimated a slightly lower growth.
The pick-up in growth will be because of three reasons. First, a series of measures had been announced since September of last year which included liberalisation of the stipulations relating to FDI and FII as well as pricing of petroleum products. Second, a serious effort is being made to remove the bottlenecks in the clearance and implementation of large projects. The constitution of a Cabinet Committee on Investment will facilitate this effort. Third, special emphasis is being laid on achieving the production and capacity creation targets in the key infrastructure sectors that lie in the public domain such as coal, power, roads and railways.
Potential Growth
In the light of India’s economic performance in recent years, a frequently asked question is whether India has the potential to grow at 8 to 9 per cent in a sustained way. In 2007-08, India’s domestic savings rate was 36.8 per cent and the investment rate was 38 per cent. Since then, these rates have come down significantly. Recent data indicate that the savings rate in 2011-12 may be 30.8 per cent and the investment rate may be 35 per cent.
However, it is to be noted that even with the savings and investment rates achieved in 2011-12 and 2012-13, we should have had a much higher growth than what we had seen. In 2012-13, the investment rate was 35.8 per cent and even after excluding ‘valuables’ it will be 33.3 per cent. Economic growth has thus declined much more steeply than what is warranted by the decline in investment. Consequently, the ICOR has risen steeply from the historic level of 4.
The main reason for this is that while capital assets have been created, their counterpart output has not flowed into the economy. Investment capital accumulated in projects is not yielding commensurate output, as implementation of projects has slowed. While even existing levels of investment should enable us to grow at 7.0 per cent over the short term, return to higher levels of savings and investment can take us back to the very high levels of growth which we had seen earlier.
Macroeconomic stability
Macro economic stability is a pre-condition for faster growth. There are three dimensions to macro economic stability. These are: price stability, fiscal consolidation, and moderate current account deficit. After almost two-and-a-half years of high inflation, we are seeing signs of decline. As of March 2013, the WPI inflation came down to 6.0 per cent. We expect to see inflation remain around that level in 2013-14. The road map for fiscal consolidation has been well laid out. The current account deficit, however, remains a source of concern, despite the fact that financing of the deficit has not been a problem so far. The current account deficit for 2012-13 is estimated at around 5 per cent of GDP. According to our calculations, it is expected to go down to 4.7 per cent of GDP in this year. If world commodity prices remain soft, the CAD in the current year could even be somewhat lower. This is still high. We must keep the CAD to a more manageable level of 2.5 per cent of GDP. We need to work on promoting exports both of goods and services and reducing imports particularly of oil, gold and coal.
In 2012-13, merchandise exports in dollar terms fell by 3 per cent. We need a road map for expanding exports through a programme of geographical and commodity diversification. As regards imports, recent years have seen sharp increases in imports of coal, oil and gold. We need to work on conservation and better utilisation of energy as part of our efforts to contain the increase in the oil import bill.
Capital Flows Impact
Capital flows add to the productive capacity of the country. They also lead to the development of financial markets. Such flows are also viewed as vehicles for the transfer of technology and management skills.
Countries normally prefer long term and durable funds. It is from this angle foreign direct investment is the most desired form of capital flows in all countries. While portfolio flows can fluctuate from year to year, very rarely does the stock get reduced. Net negative flows during a year are uncommon. It however happened in 2008-09 in India. It is found that in recent years 20 to 30 per cent of the FII inflows in India have been towards the subscription of Initial Public Offerings (IPO). They thus contribute directly to increasing the productive capacity. External commercial borrowing provides an opportunity to Indian firms to take full advantage of the conditions prevailing in international capital markets. NRI deposits no longer play a dominant role.
Volatility factor
Capital flows can be due to a combination of “push” and “pull” factors. If the investment prospects are deemed to be low or if interest rates are low in the host country, they “push” capital out.
On the other hand, the “pull” factors are the conditions that prevail in the receiving countries. Capital flows tend to be more permanent, if they are influenced by the “pull” factors.
It is normally assumed that FII inflows are more volatile than other forms. However, in the 1997 East Asian Crisis, in the case of most of the countries affected by it, the most volatile flow was bank credit.
Coming back to India, some analysis has been done of FII flows in the wake of the Lehman crisis of September 2008. During the month of October 2008, gross equity sales were Rs 68,310 crore. However some FIIs still felt that the outlook for investment in India was good. In that very month, FII purchases amounted to Rs 52,014 crore.
Putting these together, the exit by foreigners from the Indian equity market in this once-in-a-century crisis was Rs 16,296 crore. Adding up across October, November and December 2008 the overall net sale by foreigners amounted to 6 per cent of their holdings at the end of September 2008. Thus even in the worst scenario, the outflows have been modest.
Quantum of Flows
The crisis of 1991 exploded because of our inability to finance a current account deficit of the order of 3.1 per cent of the GDP. That position has changed. Thanks to the development of the international capital markets, today emerging economies including India are able to attract large capital inflows.
Net capital flows (or magnitude of the capital account) have increased almost ten-fold from $7.1 billion in 1990-91 to $67.8 billion in 2011-12. This has been a dramatic increase over the last two decades. All three primary components of the capital account: (i) foreign investment comprising both direct and portfolio, (ii) loans, and (iii) bank capital have grown.
India’s current account has been on the rise in recent years. However, financing the current account deficit has not been a problem. In 2012-13, India attracted as much as $94 billion. This shows the trust investors and others placed in India.
Of course, we must bring down the current account deficit. Capital flows into India as long as India is perceived to be a fast growing country. India’s investment and savings rate remain well above 30 per cent indicating the high potential for growth.
If we grow at 8 to 9 per cent per annum, we will graduate to become a middle income country by 2025.
(The author is Chairman, Economic Advisory Council to the Prime Minister.)
Excerpts from a talk, ‘India as an Investment Destination’, given on May 3 at Business Line’s Investment Opportunities Fair, in Chennai.