The budget season approaches. The finance minister has just held his conclave with distinguished economists, businessmen, farmers, trade unionists and other worthies. The wisdom of his advisors was reflected in the finance ministry’s mid-term review, published at the end of 2009; it will be burnished and re-exhibited in the Economic Survey next month. I indulge in economy reading once in a while, for fun and to prevent the skills from rusting. Here are the results of the latest indulgence.

Measured as change in rolling four-quarter totals, growth in gross domestic product at factor cost fell from 9.8 per cent in the last quarter of 2007 to 5.9 per cent in the second quarter of 2009. In the third quarter it jumped to 7.4 per cent. The figures are slightly different from the quarterly year-on-year growth figures that officials prefer, but the trends are about the same. They suggest to the official mind that the downturn is at an end, and that India is back on the way to nine per cent and beyond. It is the religious duty of government types to be optimistic. I would not draw conclusions from a single quarter’s figures, so I remain sceptical.

I find the figures of gross national expenditure more interesting. Its growth fell more precipitately from 9.9 per cent in the last quarter of 2007 to 4.4 per cent in the first quarter of 2009. The last two quarters’ figures are 5.6 and 6.4 per cent — slightly stronger evidence of the end of the downturn.

Why did growth turn down? The official version would be that the international economy went through a downturn, which was imported into India through the balance of payments. This has some support if we look at the trade account: the visible deficit rose from about eight per cent of GDP till the end of 2007 to about 12 per cent thereafter. That should have decelerated the economy. But the trade account is only part of international transactions; one should really look at the total including trade in services. The current account, which includes both, shows little worsening. So the evidence for believing that the downturn was imported is weak.

The second part of official mythology was that a government “stimulus” bailed the economy out of the downturn. It is perfectly true that government expenditure growth did not slow down together with GDP growth; in this sense, it moved against the trend. But its growth neither rose as GDP growth fell, nor fell as it rose. The government cannot achieve perfect anticyclicality in its expenditure since GDP figures are not known with a lag of three months; but even if we introduce such a lag, government expenditure did not vary anticyclically. It shows an enormous rise in the last quarter of 2008, and relatively lower rates of increase in other quarters. Hence if government expenditure worked against the downturn, that effect was largely accidental.

What explains the downturn? We must look for series that move with the downturn and lead it. The prime such series is the one for manufacturing. From a peak of 9.6 per cent in the second quarter of 2007, manufacturing growth fell continuously till it reached -1.4 per cent (that is, manufacturing production fell) in the first quarter of 2009. This fits and leads the downturn. Then it recovered abruptly to 9.4 per cent in the third quarter of 2009. There is one other series which behaves similarly, namely construction. But the fluctuations in its growth are less extreme, and its timing less well-coordinated with overall growth. It fell from 12.9 per cent in the third quarter of 2007 to 4.1 per cent in the last quarter of 2008. Taking the two sectors together, we can say that the downturn was led by the material sectors, namely industry and building.

These are productive sectors; what caused their growth to fall? For an explanation we must turn to expenditure on production. Here, three series fit the bill. One is private consumption, whose growth fell from 9.6 per cent in the last quarter of 2007 to 1.6 per cent in the second quarter of 2009. Another is fixed investment, whose growth came down from 15.5 per cent in the third quarter of 2007 to 3.1 per cent in the second quarter of 2009. The third is inventories, whose growth declined from 61 per cent in the second quarter of 2007 to -37.9 per cent in the third quarter of 2009. Inventory changes are really derivative from production and purchases, so we can ignore them. The best summary of what happened is that private expenditure, on both consumption and capital formation, explains the downturn.

Thus the most accurate description of what happened is that India saw a classic industrial boom between 2005 and 2007. As investment continued at high levels of 35 per cent of GDP and more, capacity was built up. It finally began to outrun demand, at which inventories began to accumulate. Then investment slowed down; as income growth fell as a result, so did consumption growth. In the past two decades, services have grown rapidly and have come to dominate the economy. So it would have been easy to believe that industrial booms and slumps had become obsolete. The conjuncture of the past five years shows this belief to have been wrong.

The above analysis is based on GDP statistics. It is mirrored in the index of manufacturing production, whose growth fell from 17.8 per cent in March 2007 to -1 per cent in December 2008. In recent months it has risen close to 10 per cent. Individual series do not mirror this course; but metals and cement do. They support the hypothesis of a classic, investment-led boom and slump.

What of the future? All the series suggest that the downturn has ended. They do not support the belief that growth will soon return to eight or nine per cent. That is a matter of faith, which we can leave to devout officials. But even an agnostic privateer would say that growth does not have to be the overriding concern any more.

Nor is inflation, according to national income deflators. But they are not available after September; subsequent retail and wholesale price indices suggest that inflation is rising rapidly. Hence the coming budget should focus on it. It should bring down the enormous deficit that was run ever since the Congress came to power. The finance minister should bring it down to zero in the next four years, and should press state governments to bring their deficits down.

They will then reduce their pre-emption of savings, and permit our substantial savings to go into productive investment. And once the government stops forcing banks to invest in government loans, they will be forced to look for borrowers in industry and services. Instead of industrialists chasing banks, banks will chase savers. Financial markets will develop and increase the efficiency of investment. In the 1990s, India freed foreign trade. Then came exports of information technology. Both those stimuli have run their course. India needs a new driver to continue high growth. Finance can be that driver in the next decade.