Earlier in the week Naveen drew our attention to a recent article in the Economist, Too hot to handle: Why the sizzling Indian economy is more at risk than China’s?. Now the article is an interesting one, but it does revisit a theme which we have already discussed a number of times on this blog, namely just how high is trend growth in India?
Ajay Shah sums the issue up nicely:
“Trend GDP growth has slowly accelerated from 3.5% to 6.5% over the 1979 to 2006 period. This has reflected a combination of economic reforms, a higher investment rate, and the “demographic dividend” from a bigger workforce.”
That is growth in an economy is the product of a demographic dividend (or penalty) factor (which may of course be neutral), an economic reforms component and a demand component (whether this comes from investment or consumption). His guess is that trend growth is around 6.5% and he does not consider that the rather higher growth numbers we have seen of late are sustainable:
“Some people believe that India has moved up to trend GDP growth of 8.5%. I believe this is not the case; that average GDP growth in the next 12 quarters will come out significantly below this remarkable performance.”
Well I just happen to be one of those people Ajay is talking about: I am even brazen enough to believe that trend growth may well have moved up beyond 8.5% going forward, and that indeed within 5 years we may well see India overtaking China in terms of average quarterly growth rates (of course this may well vary from one quarter to another, a phenomenon known as volatility, and of course 5 years from now the Chinese economy may not still be sustaining the very high growth rates we see today).
But obviously Ajay is not alone in taking the view he does, the Economist, by and large, agrees with him:
India’s trend growth rate has almost certainly increased but it is still nowhere near as high as China’s. Mr Prior-Wandesforde estimates that it is now around 6.5%, up from 5% in the late 1980s. But India’s recent acceleration largely reflects a cyclical boom, thanks to loose monetary and fiscal policy. The Reserve Bank of India has raised one of its key interest rates by one and a half percentage points to 6% over the past two years, but inflation has risen by more, so real interest rates have fallen and are historically low. This makes the economy more vulnerable to a hard landing.
India cannot grow as fast as China without igniting inflation because of its lower investment rate, particularly in infrastructure, and labour bottlenecks.
Now just one small point on this before I get more into the substantive issue, the Economist really does need to make up its mind what it is advocating, since this rather unfavourable investment comparison with China does rather conflict with earlier opinions they were voicing about the unsustainability of the investment/export driven model China seems to have, and how India was more balanced given the key role of domestic consumption, but let’s leave that on one side for the moment.
Neither am I, of course, alone in thinking India’s trend growth rate may be considerably higher than many imagine it to be. Surjit Bhalla, for example, seems to hold a somewhat similar view:
Some, however, believe that an investment boom is under way. A recent report by Surjit Bhalla of Oxus Investments, an economic research firm and hedge fund, has caused a stir by estimating that investment in the year ending in March 2007 will reach between 38% and 42% of GDP. Such investment, he says, would allow India to sustain 10% annual GDP growth.
The Economist will of course have none of this:
Sadly, Mr Bhalla’s estimate for investment is almost certainly too high. Unless saving (29% of GDP in 2004-05) has also surged over the past two years, an investment rate of 40% would imply a current-account deficit (which must equal the gap between saving and investment) of close to 10% of GDP. This does not square with trade figures and, in any case, it would hardly be a sign of economic health. Nor does a significant increase in saving look likely given strong consumer spending this year and only a modest fall in the government’s budget deficit.
Curiously though what Surjit is saying does rather fit in with what we talked about on this post here (which examined the state of play as far as potential for infrastructure investment in India goes).
And as it happens Bloomberg today have an article on the same topic in anticipation of the latest quarterly GDP numbers expected tomorrow:
India’s $775 billion economy has grown more than 8 percent in five of the past six quarters. China’s $2.2 trillion economy, Asia’s second largest, expanded 10.4 percent in the quarter ended Sept. 30, the quickest pace among the world’s 20 largest economies and almost four times the 2.6 percent gain in the 12 European nations sharing the euro….
General Motors Corp., Royal Dutch Shell Plc. and other companies have invested in about 3,000 new factories and expansion projects worth about $21 billion in India since May 2004 to cater to growing demand, according to Finance Minister Palaniappan Chidambaram.
“India’s high growth trajectory is here to stay,” said Brijmohan Lall Munjal, chairman of Hero Honda Motors Ltd., India’s biggest motorcycle maker, currently building its third factory for $420 million. “Incomes are rising, the government is spending more money to improve infrastructure. Economic growth will only get stronger from here.”
The creation of new jobs in the software industry and at call centers is putting more money in the hands of some 350 million middle-class Indians. For example, Dell Inc., the world’s second-largest personal-computer maker, opened its fourth customer-service center in India this month as it seeks to reduce costs to shore up declining profit.
Growth in India’s economy is also benefiting from Prime Minister Manmohan Singh’s decision to increase spending on roads, ports and other infrastructure by a quarter to 992 billion rupees ($22 billion) in the year that started April 1 in a bid to attract overseas manufacturing companies and spur growth to 10 percent over a decade.
Infrastructure spending is spurring demand for steel, cement and electricity in India, which spends a seventh of China’s $150 billion investment in public works each year according to Morgan Stanley.
So what we seem to have here is a win-win type cycle where an initial increase in domestic consumption (fueled to some extent by the outsourcing boom) is now moving over to an investment driven infrastructural and industrialization one. Not that this is going by any means to be an easy process to manage, but the potential for very high growth rates is there, and that, at the end of the day, is what this debate is all about. Of course India needs more efficient capital markets, of course she needs labour market flexibilization, of course the regulatory infrastructure needs to be improved, but this isn’t the point. The argument here is, even in the absence of all of this in the short term how fast can India grow, and my feeling is that it can grow a lot faster than the Economist seems to think. My reasoning? I tend to give a lot higher weighting to the demographic component than most other commentators seem willing to do, and I also think that conventional analysis often ignores the speed with which behavioural change spreads (and this at the end of the day is an important part of the productivity picture) in an age of mobile phones and internet connectedness (which is another way of saying that we should expect ‘convergence’ to be much more rapid today than it was in the past.
So who is right and who is wrong here? Well the data will tell us, now won’t it, and the first little test will come tomorrow, when we should get to know just what third quarter GDP growth has actually looked like.