It is strange how the sentiment about the economic prognosis can change so soon. Until about a year ago there was gloom about the economic prospects. We had seen the lowest growth of a decade, savings were static, the monsoon had failed continuously for three years (five in some parts of India), inflationary pressures were increasing after many years, the tiger economy of China was all set to decimate Indian manufactures with its cheap products, there was no prospect for peace with Pakistan or a decline in terrorist activity or a reduction in the consequent high defence expenditures, the imminent invasion of Iraq and the threats from top American officials of a spread of American muscle into other countries like Iran and Syria held out the possibility of further rise in oil and gas prices, and the Central government seemed unable to get its act together on many fronts. The deficits of the Central and state governments continued to be high and there was no sign that there were going to be economies in government expenditures.
Now the mood is different. The National Council for Applied Economic Research reports the highest level of business confidence in years. The Confederation of Indian Industry promises that growth this year will cross 6 per cent (against earlier forecasts by many that it would with luck approach 5 per cent). What are we to believe' Should we keep swinging from gloom to euphoria with every change in some indicators' Or can we find something more fundamental about the economy that can help us to make a better prognosis of the future'
The monsoon is obviously a key factor that affects sentiment. This is despite agriculture contributing hardly 25 per cent to gross domestic product. The reason is the 60 per cent or so who depend on it and the fact that their incomes mostly go into consumption, not saving, so that improvement in agriculture means a disproportionate boost to consumption expenditure and hence to the economy.
The boost to agricultural production because of a good monsoon will also curb inflationary pressures from food and other agricultural products. Another factor that has helped is the deterioration in the American economy with deficits rising to extraordinary levels, interest rates kept very low, a declining dollar and rising imports. This has helped the rupee. It may also have led to considerable inflows of funds into India seeking the better interest rates and the security of a stronger rupee. The governor of the Reserve Bank of India has said that there is reason to expect this strengthening to continue. Indian industries are now able to import as they need for their production and invest overseas. The stronger Indian companies have been able to borrow at low rates overseas and bring the money back to India to earn better interest even after allowing for the stronger rupee reducing the equivalent rupees. These have helped exports and to fund foreign exchange inflows.
This arbitrage opportunity is now being reduced because the government has imposed some restrictions. But the American economic situation is unlikely to change and the dollar decline may well continue. India is today an attractive currency destination. Given our restrictions on capital account convertibility, this is unlikely to be “hot” or to be volatile in the short or even medium term (two years). Our challenge is going to be to use these inflows for productive purposes instead of letting them become a burden.
Since 1995 there has been little addition to manufacturing capacity. The time is now right for this to begin. The attractiveness of India as an investment destination has led to foreign investors buying up existing capacities but new investments, largely on a “full control” basis in many areas, like automotive products and ancillaries, information technology, pharmaceuticals, research and development centres, and others, is likely to grow. India’s attractiveness as an investment destination has been enhanced by the weaknesses in southeast Asia, the SARS epidemic in China and southeast Asia, the poor returns on investments in China as compared to India and the fears about terrorists in many southeast Asian countries. Indian companies are taking advantage of this climate to raise equity funds overseas. This should reflect in better responses to primary issues in India. These have been very poor for many years and resulted in poor capital formation and capital investment.
The good corporate results have been due to the savings in interest costs, better use of working capital and significant improvements in costs of inputs because of the last few years of exercises in introducing information technology, supply chain management, and so on. Now the demand situation will also improve and this should lead to even better corporate results. We can confidently expect a boom in industrial production in the coming years. This will be helped by exports as companies cash in on the nurturing of export markets of the last few years.
Further, interest costs will continue to decline, being much higher in real and nominal terms than in most other countries. The banks are awash with liquidity and need lower interest rates to compete with companies who are going overseas or directly to investors for funds. This will have beneficial effects both on consumption (because of cheaper loan funds) and on investment. Again the economy will benefit.
The government appears at last to have got its policies on disinvestments and the role of the private sector in better shape than it was. This has helped the stock market, as has the considerable improvement in the performance of nationalized banks and many public sector companies. Despite this, the privatization of state owned companies appears to be making headway.
There is also the puncturing of the China competition balloon. Chinese products have made little dent in Indian markets. Indeed many Indian companies are now going to China for the cheap inputs and labour costs. They are welcomed because of the technology and engineering skills that they take there. This is making these companies competitive not only in China and India but also in global markets.
The last year has also seen other changes that account for the euphoria about the future. The prospects of another war with Pakistan have dimmed greatly. Terrorism across the border appears to be in decline. There seems to be a general improvement in India-south Asia relationships as evidenced by the progress with Sri Lanka and Nepal and the possibility that the Bangladesh fears and suspicions about India might be on the wane.
India’s relationships with the rest of the world also appear to be on a much better plane. There seems to be acceptance that India is a nuclear power with strong missile and space capability developed by it. The improvement in relations with Israel augurs well for further improvement in relations with the United States of America.
Thus it is the culmination of many initiatives that seem to be fructifying together. The riots in Gujarat, communal killings, the mosque-mandir controversy, do not seem to have affected the confidence adversely. There is another intangible factor and that is the role of the president. For the first time we have a president who truly believes that India is a great country, that it will be a developed nation by 2020, that it has a great people with enormous intellectual capital who can make good use of technology to develop the nation. His willingness to repeat this mantra ad nauseam may be having an effect in improving the confidence and “feel good” attitudes of the majority of Indians.
So is India on a roll' Euphoria is not a good thing because it can be dashed by small setbacks. India has always had many things going for it. They have all come together today. People need to be made aware of the good things that are happening while trying to correct the bad. Positive attitudes will lead us to development and growth. If we feel we are on the upswing we will be so.