Macroeconomic overview

Introduction

1.1 The Indian economy is expected to grow by 5.9 per cent in 1999-2000. More importantly, an industrial recovery seems finally to be underway from the cyclical downturn of the previous two years. Growth of GDP from manufacturing will almost double to 7 per cent in 1999-2000 from 3.6 per cent in 1998-99. The growth in GDP from the construction sector is expected to accelerate to 9.0 per cent in 1999-2000 from 5.7 per cent in 1998-99. The performance of infrastructure sectors improved markedly. The inflation rate dropped to international levels of 2 to 3 per cent for the first time in decades. The balance of payments survived the twin shocks of the East-Asian crisis and the post-Pokhran sanctions with a low current account deficit and sufficient capital inflows. This was demonstrated by the continuing rise in foreign exchange reserves by over US $ 2.4 billion during the year until the end of January, 2000 coupled with a relatively stable exchange rate. Export performance has improved on par with the better performing emerging economies. The restoration of confidence in industry has been best reflected in the rise in the stock market during 1999. Primary issues have increased by almost half during the first nine months of 1999-2000.

1.2 Inflation dropped dramatically in 1999, surprising many observers by remaining at low levels. As of January 29, 2000, the annual inflation as measured by the WPI was 2.9 per cent (point to point), down from a peak 8.8 per cent on September 25, 1998 . The inflation rate has been less than 4 per cent since April 1999, with the result that the average (52 week) inflation was 3.3 per cent (provisional) as on January 29, 2000. The decline in inflation as measured by the CPI for industrial workers has been even more dramatic, falling to zero in November 1999 from a peak of 19.7 per cent in November 1998. The strong agricultural growth in 1998-99, the increasing openness of the economy to manufactured imports along with the fall in international prices has contributed greatly to this decline. With the removal of import and export controls on agricultural products and their replacement by a rational, stable tariff structure, sharp fluctuations in agricultural prices arising from domestic supply shocks could also be greatly moderated.

1.3 Exports showed a strong recovery in 1999, growing by 12.9 per cent in April-December 1999 in US $ value (DGCI&S customs data). Software exports, which are not captured in the customs data, also continued to show vigorous growth of over fifty per cent during April-September 1999. Despite a 57.8 per cent growth in the US $ value of oil imports in April-December 1999, overall import growth remained at a manageable 9.0 per cent. As a result the trade deficit was lower in value (US $) during April-December 1999 as compared to April-December 1998. Non-oil imports, however, grew by only 1.1 per cent in this period, as prices of non-fuel primary commodities were projected to fall in 1999 by over 11 per cent and unit values of manufactures by about half a per cent. The downturn in gold and silver imports and the sharp fall in imports of capital goods (by about 30 per cent for April-November 1999) also contributed to the slow growth of non-oil imports.

1.4 The current account deficit, which defied gloomy forecasts based on the presumed after effects of the Asian crisis and the economic sanctions, ended at 1 per cent of GDP in 1998-99. This was because international price declines affected both imports and exports. With the sharp rise in oil prices the current account deficit is expected to revert to a more normal level in 1999-2000. During April-September 1999 the current account deficit was higher than in the first half of 1998-99 and is expected to end the year at about 1.6 to 1.8 per cent of GDP. During the same period net capital flows have grown by over one-third. This suggests that the increase in the current account deficit will be financed quite comfortably. Both portfolio investment and non-resident deposit inflows have shown significant improvement. FDI flows, however, continue to be lower, and this is a source of serious concern, particularly given the medium term target of US $ 10 billion of FDI inflows. An expansion of the "automatic route" coupled with further liberalisation should help reverse this trend next year. ECB inflows also remain sluggish, but this is mainly due to weak domestic demand and easy liquidity available for corporations in the domestic market.

GDP, saving and investment

1.5 There was a sharp upturn in GDP growth in 1998-99, which reversed the deceleration in growth seen in 1997-98. GDP (at factor cost) growth accelerated to 6.8 per cent in 1998-99 from 5 per cent in 1997-98 ) . The primary supply side factor for the recovery was agriculture. GDP from the agriculture and allied sectors, which had fallen by 1.9 per cent in 1997-98 recovered dramatically to grow by 7.2 per cent in 1998-99. GDP from agriculture & allied sectors hence contributed 1.9 per cent points to the overall growth rate of 6.8 per cent in 1998-99. As in the previous year GDP from "public administration & defence" contributed 0.7 per cent point to the overall GDP growth rate in 1998-99. This was primarily because of the wage increase for government employees consequent to the Fifth Central Pay Commission’s recommendations. The wage increase was largely implemented by the Central Government in 1997-98 and by the Sate Governments in 1998-99.

1.6 Unlike in 1997-98, when the GDP from manufacturing had led to a substantial decline in GDP growth; the growth rate of manufacturing at 3.6 per cent in 1998-99 was only 0.4 per cent point less than the year before. GDP from electricity, gas and water supply and from trade, hotels and transport grew faster in 1998-99 than the year before, while mining and quarrying suffered decline, construction and financial services showed marked deceleration.

1.7 On the demand side, private consumption recovered in 1998-99 from its slump in 1997-98, with real consumption growth doubling from 2.6 per cent in 1997-98 to 5.1 per cent in 1998-99 . Recovery in agricultural income clearly contributed to this growth as indicated by the lower saving rate in terms of household saving in physical assets. Perhaps the windfall income of government servants, which was initially saved also started getting spent. Growth of government consumption expenditures in real terms has accelerated to 14.5 per cent in 1998-99 from 10.6 per cent in 1997-98. This provided an even greater stimulus to demand than in the previous year and contributed 1.6 per cent points to overall demand growth in 1998-99.

1.8 A sharp slump in investment, however, had a deflationary impact and countered part of this stimulus. Total investment (at 1993-94 prices) declined by about half a per cent in 1998-99 after increasing by over 13 per cent the year before. This deceleration in investment was linked to the deceleration in manufacturing and the slump in agriculture in 1997-98. Average real interest rates, as measured by the cut-off yield on 364-day treasury bills (adjusted by the WPI inflation), declined by 1 per cent point in 1998-99. Though this followed a decline in the real rate by 2 per cent points over the previous year, it was not sufficient to counter the negative factors.

1.9 Gross domestic saving declined sharply in 1998-99 to 22.3 per cent of GDP . The 2.4 per cent points of GDP decline in the saving rate resulted from a 1.4 per cent point decline in public saving and a 1 per cent point decline in household saving in physical form (i.e. direct investment). The corporate saving rate also declined to 3.8 per cent of GDP in 1998-99 from 4.3 per cent of GDP in 1997-98. Though household financial saving increased as a proportion of GDP, the overall private saving rate declined by 1 per cent of GDP. The decline in saving rate of the government and households is a counterpart of the higher consumption growth during 1998-99. Though in the short run, growth in government consumption may have had a positive effect on aggregate recovery, government dis-saving (mainly reflecting high revenue deficits) will have to be reduced if aggregate investment and growth of the economy is to increase.

1.10 Real gross domestic capital formation in 1997-98 at 26.9 per cent of GDP (constant price) was only marginally less than the previous peak rate . It however declined in 1998-99 to 25.1 per cent of GDP, marginally less than the five-year average. About half of this decline was due to a fall in household investment, as it reverted back to its earlier trend after a sharp rise the previous year. Lower investment in the trade sector was a factor in this decline. The lagged effects of poor agricultural performance contributed to this decline. The other significant factor was a halving of the errors & omissions component of gross capital formation. It was quite encouraging, however, that despite two years of rather slow growth in manufacturing, corporate investment edged up to 8.8 per cent of GDP (constant prices) in 1998-99. It suggests that companies are responding to the challenges of competition by upgrading their plant and machinery.

1.11 Gross fixed capital formation (GFCF) declined by only 0.3 per cent point to 23 per cent of GDP (constant price) in 1998-99. This is around the same as the five-year average. The decline in GFCF was attributable to a 0.6 per cent point of GDP decline in household fixed investment to 7.7 per cent of GDP (in 1998-99). Both the corporate and public fixed investment rate increased marginally. Corporate fixed investment at 8.7 per cent of GDP (constant price) in 1998-99 was close to its peak of 8.9 per cent in 1996-97. Public fixed investment rose from its previous year trough of 6.4 per cent to 6.6 per cent of GDP (constant price). An important factor from the perspective of future productivity improvement was that growth in investment in machinery and equipment (in 1993-94 prices) accelerated to 4.9 per cent in 1998-9. It had decelerated sharply in 1996-97 and declined further in 1997-98 to almost nil.

1.12 Inventories as a proportion of GDP (constant prices) after a build up of 0.7 per cent in 1997-98 declined by 0.4 per cent of GDP in 1998-99. One fourth of this was in the public sector and three-fourth in the private sector (Table 1.5).

1.13 As direct data on capital formation is not available for 1999-2000 we have to look at various indicators. These present a very mixed picture. Though growth of domestic capital goods production remains reasonably good, it is decelerating. Imports of capital goods have, on the other hand, fallen sharply. Growth in disbursements by development finance institutions has decelerated, while that by Investment Institutions has accelerated. Growth of sanctions has, however, decelerated for both sets of institutions. While primary issues have reversed the declining trend of several years by a 46% rise, foreign direct investment (FDI) has declined for the second year in succession. The average real interest rate as measured by the 364-day treasury bills cut-off yield (using the WPI) is about 5 per cent points higher during the first 9 months of 1999-2000 than it was in 1998-99. Investment growth is likely to revive with the recovery of private aggregate demand. Sustaining high growth will, however, require a steep rise in FDI, a structural reduction in inflationary expectations, reduction of the fiscal deficit and the elimination of remaining interest controls and rigidities in financial markets.