October 29, 2006

Understanding the GDP Growth

Ajay Shah, links to one his articles on his blog, about understanding the high GDP growth rate in India over the last few years, and provides reasons for the same. Here is what he has to say

The first quarter 2006 GDP growth figure of 8.9 percent has surpassed all forecasts. It was the 12th consecutive quarter in this streak of marvelous high growth in India, which began from the Jun-Sep 2003 quarter. In this three-year period, the mean and median of growth was roughly 8.4%. Three years at 8.4% GDP growth in India have never happened before.

Some people believe that India has moved up to trend GDP growth of 8.5%. I believe this is not the case; that average GDP growth in the next 12 quarters will come out significantly below this remarkable performance.

Trend GDP growth has slowly accelerated from 3.5% to 6.5% over the 1979 to 2006 period. This has reflected a combination of economic reforms, a higher investment rate, and the "demographic dividend" from a bigger workforce.

Layered on top of this slowly accelerating trend is a business cycle. This is a new phenomenon, which was not found when India was a socialist country, and one which has been a key feature of Indian macroeconomics from the mid 1990s onwards. We had a low of the business cycle in 2001-02, which was followed by a high of the business cycle which we are presently in. The 12 quarters of 8.5% growth reflect a combination of trend growth at 6.5% with an extra two percentage points owing to favorable business cycle conditions.
So, according to him India was just riding high on good times, things would start looking dull soon. A little later Ajay also mentions that the world economies are going to fall soon, including the US, (similar to what was predicted here), and it would prompt India to fall too.

Here is his remedy.
One element of the economic reforms program that is needed is an examination of fiscal policy, monetary policy and banking regulation, seeking to address the problem of their being destabilising (i.e. procyclical). This would reduce the extent to which India suffers from these patterns of boom and bust. Sound fiscal institutions and sound banking regulation can reduce the extent to which these two elements are destabilising. The big opportunity is with monetary policy. Instead of doing harm by being destabilising, as is the case today, it can be the mainstay of countercyclical macroeconomic policy, as is the case in all mature market economies. This requires the creation of a monetary authority with the narrow mandate of achieving an inflation target.