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Doubtful Macroeconomics

Doubtful Macroeconomics The Planning Commission has done well to release the draft of the approach paper to the Eleventh Five-Year Plan (2007-08 to 2011-12) entitled

June 24, 2006 E L L WEEKLY
Doubtful Macroeconomics The Planning Commission has done well to release the draft of the approach paper to the Eleventh Five-Year Plan (2007-08 to 2011-12) entitled ‘Towards Faster and More Inclusive Growth’ for public debate. The approach paper envisages a step up of the growth in gross domestic product (GDP) from a baseline of 7 per cent to 9 per cent, which will require an increase in the gross investment rate from 29.1 per cent to 35.1 per cent of GDP. This implies a reduction in the incremental capital-output ratio (ICOR) from 4.16 to 3.9 and a consideration of the implications of the growth target for investment and saving in the economy. The higher level of investment is to be financed by a combination of increased domestic and foreign savings. The gross domestic savings rate is expected to go up from the baseline of 27.1 per cent of GDP to 32.3 per cent of GDP, while the current account deficit is expected to rise from 2.0 per cent of GDP to 2.8 per cent of GDP in the 9 per cent growth projection. Interestingly, a significant part of the increase in domestic savings is to come from “strong budgetary discipline by both the central government and the state governments”. The negative effect this may be expected to have on household savings is not even contemplated. Clearly, as a first take on the approach paper, a critique of the broad macroeconomics is called for. With regard to the feasibility of the higher investment rate, besides the possibility of raising the domestic savings rate (which we have doubted), the answer revolves around access to foreign sources of financing domestic investment. The savings conundrum is, of course, complicated by the fact that in a demand constrained system, it is investment that determines savings rather than the other way round. But coming to the question of foreign finance for domestic investment, a higher GDP growth – the approach paper settles for an average growth rate of 8.5 per cent over the Plan period – implies a greater demand for imports of capital, intermediate and consumer goods in what would be an increasingly open trade regime. But, according to the approach paper, exports of goods and services are expected to grow at a higher rate of 16 per cent, compared to import growth of 12.1 per cent. The approach paper is in fact quite upbeat about the prospects of exports – especially that of software and IT-enabled services, as also pharmaceuticals, auto components and even textiles and clothing. But the import intensity forecast seems significantly underestimated, raising the prospect of a larger inflow of foreign capital or a cutback in the investment rate becoming necessary, leading to a failure to meet the targeted GDP growth rate. Leaving aside the problems of implementation, the focus areas of the Plan in the approach paper do not seem to be very different from that of the Ninth and Tenth Plans. One is an envisaged step up of investment in infrastructure (irrigation, roads, ports, railways, power, telecom, and so on) from 4.6 per cent of GDP to somewhere between 7 and 8 per cent of GDP, through “an aggressive effort at promoting public-private partnership”. These so-called PPPs – championed by the World Bank all over the developing world – have been discredited for making public resources available for private gain at the expense of the public, but the Planning Commission is not looking for alternatives. It envisages the possibility of “model concession agreements”, transparency, competitive bidding, and stakeholder consultations in future PPPs. The second focus area is agriculture, whose revival is seen as one of the main keys to “faster and more inclusive growth”. Here it is heartening that the demandside is also given its due. But the strategy of stepping up the agricultural growth rate from less than 2 per cent to an average of 3.9 per cent in the Eleventh Plan is more of a supply-side strategy than a demand-side one. The agricultural strategy does not take account of the fact that the very effort to raise the domestic savings rate through “strong budgetary discipline by both the central government and the state governments” is going

to lead to an increase in electricity and water rates, as also of other input prices. No indication is provided as to the likely impact of these on the rate of return (profitability) in agriculture.

The third focus area is the provision of essential services

– “education, health, and other basic public facilities”. Here it is curious that in the approach paper, the subsidised public distribution system, even its targeted version, does not merit more than passing mention. All the same, given the various commitments made in the national common minimum programme that the approach paper says, “must be further strengthened and consolidated into a strategy for the Eleventh Plan”, the social sector outlay must eventually be considerable.

All said and done, one must stress that the macroeconomics of the Plan, as presented in the approach paper, is one of private investment led growth. Now, given primary and secondary uncertainty, atomistic investment decisions by private players, and the government’s progressive withdrawal from its role as a counter-cyclical stabilisation agency (and constrained by the Fiscal Responsibility and Budget Management Act), aggregate investment demand and its composition are bound to ultimately differ widely from what the Plan would envisage. mrn

Economic and Political Weekly June 24, 2006

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