Steaming On

A few months ago, the long-term India growth story encountered its first major challenge in a long time: The inflation monster was threatening to veer out of control, interest rates continued to stretch northward, corporate earnings appeared set to be impacted by a base effect, and the stock markets, as a result, were losing direction. Pundits were beginning to squirm in their armchairs, as they politely cleared their throats to ask the question: Can the Indian economy sustain growth rates of 9 per cent-plus over the coming years? It's a raging debate that has for some time now dominated various conferences and conclaves, and continues to grab plenty of headline space in the media.

But for all the talk, the numbers from the economy have never ceased to surprise on the upside. In fact, they have often beaten analysts' consensus estimates by huge margins. Consider: Last year's GDP numbers were revised upwards to 9.4 per cent, from 9.2 per cent, making it the fastest economic expansion in 18 years in India. The growth momentum seems to have accelerated further in the first month of this financial year. The country's industrial output increased 13.6 per cent in April 2007, higher than consensus estimates of 11.3 per cent. The manufacturing sector played a key role in the growth story this time, stealing the limelight from the normally buoyant services sector. This segment, which comprises 79 per cent of the industrial output, surged 15.1 per cent year-on-year in April, despite doubts whether manufacturing could sustain productivity gains on the back of rising interest rates.

Rising inflation has been a major worry for the policy makers. But there are signs of it getting tamed thanks to the Reserve Bank of India's (RBI) measures to tighten money supply, which have begun paying off. Inflation has eased to a 13-month low of 4.3 per cent, from the level of 6.58 per cent in January. This fall has been higher than consensus estimates of 4.5 per cent, and is well below the government's target inflation rate of 5 per cent. Tough measures by the government like banning wheat and pulses exports and reducing duties on fuel have helped bring down crucial prices of fuel items, notwithstanding the hardening rupee that made imports cheaper and helped cool inflation.

But the growth story has just one glitch: Slowing demand. Rising interest rates have had some effect on interest rate sensitive sectors such as housing and cars as sales growth has started tapering off. It also does not seem likely that the interest rate cycle has peaked. The RBI is unlikely to ease interest rates, even though inflation is slowing down; in fact, the central bank is expected to persist with its tight money policy. Says Ananda Bhoumik, Senior Director, Fitch Ratings: "The interest rate cycle has probably not peaked. If that (a high interest rate regime) continues demand will be affected."

But the bigger heartening story is that the structural growth story of the Indian economy is really getting stronger. A spate of mega-investments by the Indian corporate sector should keep the growth engines of the economy ticking along nicely. Investments by the corporate sector are expected to continue in a big way for the next three years at least. Says Bhoumik: "We are pretty firmly in the midst of an investment cycle which is expected to continue at least for a couple of years."

The investment-led economic boom should be able to fuel the growth. There have been supply side constraints that were a major hindrance driving up prices of essential products and food grains. But investments increase the capacity of the economy to produce more goods, which should also help keep the inflation pressures on the economy in check.

With the manufacturing sector essentially leading the way and heavy investments planned in power and construction, the government's ambition of clocking average 9 per cent growth rates is not a pipe dream. As companies invest in the supply chain, the efficiencies brought about in agriculture and the farm sector could be immense, keeping prices of food items in check. Productivity gains from economies of scale will further improve efficiencies. It's these structural changes that could sustain the growth rates of the economy. It's time the debate is laid to rest.