A Note on the Macroeconomics of the Twelfth Five-Year Plan

The purpose of this note is to argue that the macroeconomics underlying the Twelfth Five-Year Plan is theoretically flawed. There are inter alia three propositions in the realm of macro­economics that the Plan accepts as being characteristic of the Plan period. First, India’s current account earnings are likely to be affected by world economic conditions and cannot be deemed to be supply-constrained. Second, I­ndia’s gross domestic product (GDP) cannot be deemed to be demand-constrained. And, third, India’s current account deficit can be brought down by raising its savings rate relative to its investment rate. These three pro­positions cannot hold simultaneously, except in a very special case which has little relevance in this context and which the Twelfth Plan neither invokes nor subscribes to.

The first proposition figures in the section “Implications for the Balance on Current Account” in Chapter 1 of Volume 1 of the Twelfth Plan document. The section begins with the statement: “Slower growth in the industrialised countries means that our exports to these countries will be adversely affected”. The second proposition can be inferred from the fact that the Twelfth Plan assumes anincremental capital-output ratio (ICOR) that is almost exactly the same as was actually experienced in the Eleventh Plan (which, except in its last year, did not, according to the Twelfth Plan, face any demand constraints, and where, even for the last year, infrastructure constraints are also brought in to explain slower growth). The Twelfth Plan expects a growth rate of 8.2% over the Plan period with an average fixed investment ratio of 34%, which gives an ICOR of 4.15 years. The corresponding figures for the Eleventh Plan were 7.9 and 32.9 respectively, giving an ICOR of 4.16 years. Since growth in the Eleventh Plan, except in the last year if at all, was not supposed to have been constrained on the demand side, the fact of taking an identical ICOR clearly suggests that it is not expected to be constrained on the demand side in the Twelfth Plan either, which is the second proposition above. The third proposition figures in the section “Longer Term Increase in Investment and Savings” again of Chapter 1 of Volume 1, where it is said

Higher levels of investment have to be supported by a sufficient expansion in domestic savings to keep the investment-savings gap, which is also the current account deficit, at a level which can be financed through external capital.