Indian economy well set now

Does India's recent growth performance represent a cyclical high or does it mark a trend? The debate has been inconclusive thus far but the optimists- to which school I belong- have been gaining ground.

The sceptics say that India is booming only because the world economy is booming; the moment, world economic growth decelerates- and there are any number of reasons this could happen- we will be back to 6% growth. They worry that growth is consumption-driven and this could be spiked by rising interest rates and household debt. They claim there are clear signs of over-heating in the economy. I address these concerns in a recent ET column.

Here, let me dwell a little more on the first argument, namely, that greater integration of the Indian economy with the world economy spells trouble in a global downturn. It is said that the true measure of dependence on the world economy is not just the ratio of exports/GDP. We need to look at (exports+invisible receipts)/GDP because invisible receipts, driven by software exports, have risen fast. The ratio of (exports+invisibles)/GDP has risen from 8.2% in 1990-91 to 24.6%.

True, but experience shows that invisibles are not very elastic with respect to a slowdown in the world economy. Remittances from overseas Indians are not greatly affected by a slowdown. As for software and other invisible exports, these are part of the "off-shoring" phenomenon intended to make overseas firms more competitive. As conditions abroad worsen, one could expect "off-shoring" to rise, not fall, as firms struggle to cut costs.

So the impact of a global slowdown will be adversely felt mainly export of goods. That ratio is now 13%. Let us say that export growth falls by half to 10%. Adjusting for the correspoding fall in imports, India's GDP would decline by 1%, still giving us growth of over 7%. That's why I say that the cyclical component of India's growth should not be overstated.

A key factor underpinning India's improved growth outlook is the increase in the savings rate- from 23.6% in 2001-02 to 29.1% in 2004-05. I believe this figure must have gone up even further. Higher domestic incomes would translate into more saving; there has been further improvement in government finances as measured by the comibined fiscal deficit of the centre and the states; and corporate profits have improved dramatically. I would not be surprised if the next release of figures for savings show a big jump.

Read my ET column on India's growth prospects here.