How hard will India's economic growth be hit by the global financial crisis and recession? Widely varying forecasts for the next financial year, 2009-10 have been made by three leading economists — Arvind Virmani, chief economic advisor of the government; Raghuram Rajan, economic advisor to the prime minister; and Rajiv Kumar, head of the Indian Council for Research on International Economic Relations (ICRIER).
These forecasts can be dubbed the good, the bad and the ugly. I would opt for the second of these. I suspect the times ahead will be bad, rather than good or really ugly.
Virmani, an incorrigible optimist, sees good days ahead. He thinks that after decelerating to maybe 7.5% this fiscal year, growth will rebound strongly to 8.5% in 2009-10. Rajan, however, believes that bad days are ahead. He predicts a dip to between 5% and 7% next year. Rajiv Kumar paints a truly ugly scenario. Using a model that has proved accurate in the past, he warns that GDP growth could slow to just 3.9% in 2009-10. Ugh!
Let's consider the three forecasts in detail. Virmani has done possibly more research than any other economist on sources of Indian growth. He says India's growth is based essentially on investing its own savings, and so is relatively insulated from global finance and fashions. India's savings rate has shot up from 23.5% in 2001-02 to 37.4% today, a phenomenal achievement.
Virmani thinks that high savings constitute a structural change that is here to stay. This will suffice to finance an investment rate of at least 36 % of GDP. So, given that output in India rises at roughly a quarter the rate of investment, he believes GDP growth of 9% should be sustainable.
Sceptics point out that India is now substantially integrated with the global economy. Exports plus imports are now 45% of GDP, so a global slowdown will surely hit India hard. Virmani, however, points out that India's net exports are very low. Unlike China, India's current account has more or less been in balance in the last five years. So, he thinks India can survive a fall in export demand, as it will be offset by a fall in imports too. Our top exports like gems and jewellery, textiles and petroleum products are based wholly or substantially on imported raw materials.
I have fears on two scores. First, savings tend to shoot up in good times and fall in bad times. In a boom, people don't spend their entire increase in income, so savings increase. But they dip into these savings in bad times, 'dissaving' instead of saving. Corporate profits boom and bust along with the economic cycle, and so do government revenues. So, I fear that the sharp rise we have seen in India's savings rate is more cyclical than structural, and that our savings will decline sharply in the global downswing.
Second, high investment does not automatically translate into high growth. It can also translate into excess capacity and bankrupt companies if the investment has been made in areas for which demand dries up, as happened during the Asian financial crisis. I do not think India can boom while the world economy is slumping. Virmani's prediction of an Indian bounce-back depends on the US bouncing back within the next few months. The chances of this look slim.
Next, consider Raghuram Rajan's forecast of 5-7% growth. This range is so wide that he has a good chance of proving right. If the world economy recovers in the next six months, the upper end of his range — 7% growth — looks feasible. This will mean little deceleration from the current year and hence, little additional pain. This scenario depends on a resumption of global growth early in the next fiscal year. This is unlikely.
More likely is a troubled, hobbled global economy for most or all of 2009. Even if there is a recovery, it may be feeble. In such circumstances, India's growth may tend toward 5%, the bottom end of Rajan's forecast.
Finally, things could get really ugly if we go by Rajiv Kumar's ICRIER model, which predicts growth of just 3.9% in the first half of the next financial year. This model has some credibility: it predicted the 9% boom in 2007-08, and was among the first to indicate a slowdown this year. It is based on 10 leading economic indicators, including GDP growth in the US and Europe, factoring in the global slowdown.
How do I assess the good, bad and ugly forecasts? Chances of good times ahead — 10%. Chances of bad times — 75%. Chances of truly ugly times — 15%. I remain a long-term optimist, but the coming year will be tough.