Is India finally flying?

Real gross domestic product (GDP) at factor cost has grown 8.1% annually in the last three years (2003-04 to 2005-06). A key question is whether this rate represents a business cycle effect or fundamental shift in the trend growth rate.

The accompanying chart helps explain the complexity of the issue. In the first three years of the 1990s, the GDP grew 4% annually. In the following four years, the growth rate jumped to 7.1% but only to fall back to 5.2% in the succeeding five years. Underlying these fluctuations, the trend growth rate was approximately 6%.

In the late 1980s, the long-run growth rate had shifted up to 6% from its prior level of approximately 4.5%. Growth rate in the last three years shows signs of yet another break in the trend rate but it may also represent a sharp upturn in the business cycle, in which case the growth rate may decline significantly in the coming years. It will be two or three years before we feel confident of a shift in the trend.

Nevertheless, one thing about which we can be confident is that the Indian economy has produced some spectacular successes in the last three years not seen before — successes that rival the performance of the Chinese economy. In turn, these successes have fundamentally altered the initial conditions with important longer-term implications.

These successes also raise doubts about the fears expressed by some that the high growth rate may reflect rising error in the measurement of services that happen to account for a large part of the high GDP growth rate. Evidence from some sectors that we can measure with reasonable accuracy points to very strong growth impulses in the economy.

The first striking observation is that in the last three years, the economy has grown a phenomenal 19% per annum in current dollars. In 1990-91, the GDP in current dollars was $317 billion. During the last three years, the GDP has increased by $327 billion.

To put the matter even more dramatically, given the US inflation rate of 3%, the GDP in real dollars grew at the annual rate of 16% in the last three years. If this momentum can be sustained — a virtual impossibility — the Indian GDP would rise from its current level of $800 billion to cross the current US GDP of $12.5 trillion in just 20 years!

One important reason why this growth represents something very real is the near spectacular expansion of India’s trade during the last three years. In 1990-91, merchandise export stood at $18.1 billion in current dollars. In the last year, exports increased by more than that amount. Alternatively, 1990-91 exports took nine years to double.

In contrast, the recent doubling has taken place in just three years: from $52.7 billion in 2002-03 to $102.7 billion in 2005-06.

Services exports tell much the same story: from a low level, they were multiplied by a factor of 3.5 during 10 years between 1990-91 and 2000-01. But starting from a much higher level, they were multiplied by 3.7 in just five years between 2000-01 and 2005-06.

The ratio of goods and services exports to GDP rose from 11.6% in 1999-00 to 15.6% in 2002-03 and to 20.5% in 2005-06. The latter change is dramatic since it took place in the presence of the GDP growth of 19% per annum in current dollars.

Thanks to the rapid expansion of foreign portfolio investment, the total foreign investment flow has risen from $6 billion in 2002-03 to $20 billion in 2005-06. Remittances from abroad have risen less dramatically. But they too have gone up from $17 billion in 2002-03 to $25 billion in 2005-06.

The story in telecommunications is now quite well known. In 1990-91, India had just five million telephone lines in total. Currently, telephone lines are expanding at the rate of more than five million per month. In urban areas, teledensity has reached 31% — a level unthinkable even five years ago. Teledensity in the rural areas at 2% remains low. But to put the matter in perspective, as recently as 1991, urban teledensity was below this figure.

The communication sector as a whole has been growing 24% per year in real terms since 1999-00. Its share in the GDP has more than doubled from 1.6% in 1999-00 to 3.5% in 2004-05.

Automobile sector offers yet another example of dramatic expansion. The sales of passenger vehicles have risen from 707,000 in 2002-03 to 1.14 million in 2005-06. The total turnover of the automobile industry rose from $12.3 billion in 2002-03 to $19 billion in 2004-05. Likewise, construction sector has shown robust growth of 12% per annum in the last three years.

At least three factors distinguish the current expansion from the one during 1993-97. First, trade expansion and therefore integration into the world economy in the current phase has been much more rapid and deeper. Second, the exchange rate in the current phase has been either stable or has appreciated.

This has meant a very rapid growth in the GDP in dollar terms when converted at the market exchange rate. Finally, after three consecutive years of 7% plus growth, the previous phase saw growth rate plummet to 4.8%. The current phase has so far shown no sign of slowing down.

But the current phase also shares one major weakness with the previous phase: labour-intensive manufacturing has remained sluggish. The end to licensing and to the small-scale industries reservation in most labour-intensive products has still not produced a major success in this sector.

The reasons for this sorry phenomenon are well known (labour market rigidities facing large-scale producers, infrastructure bottlenecks and bureaucratic red tape). Unfortunately, without rapid expansion of the unskilled-labour-intensive industry, progress towards poverty reduction and transition to a modern economy will remain far slower than is feasible.

(The author is professor at Columbia University)

Economic Times September 20 2006