Drought-proofing India

Indian Express, 9 August 2004

Forecasts for GDP growth in the Indian economy have been revised downwards as a result of the monsoon scenario. But even though growth projections for agriculture are negative, the growth projection for GDP remains positive. Growth is not expected to fall drastically. For instance, in CRISIL’s recent forecast, agricultural GDP is projected to be minus 2.5 per cent, as a result of the drought. But GDP growth projections have only been revised downwards from 6.2 per cent to 5.6 per cent. This is a big change, as compared with previous decades when GDP was known to drop when there was a bad drought.

How does a drought translate into a fall in growth? Since agriculture constitutes about 25 per cent of GDP, a four percentage point decline in agricultural production should directly translate into a one percentage point decline in GDP growth. In addition, there are other effects. The linkages between agriculture and GDP arise from both the demand and the supply side. On the demand side, when agriculture does well, rural incomes rise. A rise in rural incomes leads to greater demand for industrial products. It has been seen that consumer goods do well when rural incomes rise. In some cases the impact is immediate, in others the effect comes with a lag. The sales of shampoos, soaps and bicycles might respond immediately, whereas the sales of motorcycles, fertiliser, tractors and televisions may have a lagged impact.

On the supply side, increase in agricultural production increases the supply of food and raw materials. Cereals, fruit, vegetables, milk, meat, eggs, etc enter the consumption bundle of all households. Their plentiful supply and lower prices, following a good monsoon, reduces the cost of living. Real incomes of both the urban and rural population increase. They both have more to spend on non-agricultural products. Also, there are a large number of industries that use farm products as raw materials. Products such as sugarcane, jute, cotton and oilseeds are directly used by industry. Cleaper raw materials augur well for these industries.

These linkages were very strong in the past. In the period before the 1990s droughts were accompanied by a drop in GDP growth. The economy did not grow slowly only in that year, it continued to grow slowly even beyond that year into the next year. The hit to the economy was enormous. Annual GDP growth became negative in four years: 1957-58, 1965-66, 1972-73 and 1979-80.

In the 1950s a less than 5 per cent decline in agriculture led to a fall in both GDP-industry and in total GDP. But this has not happened since the 1990s. The last time GDP saw an actual decline was in 1979-80. This was the result of both a very bad monsoon, which resulted in agricultural output falling by a shocking 13 per cent, and an oil price shock. In that year, industrial growth declined by over 3 per cent, and GDP fell by 5.2 per cent.

However, in the 1980s and 1990s when agricultural output declined, though industrial growth slowed down, industrial production did not fall. Even when agricultural output fell by 5.2 per cent in 2002-03 (a very bad monsoon), industrial growth remained positive and GDP grew at 4 per cent. As a consequence of the change in the importance of agriculture in industrial and total GDP in the economy, the Indian economy is witnessing industrial business cycles, rather than monsoon cycles.

What is responsible for this change? The most important factor is that non-agricultural sectors have been growing faster. Consequently, the share of agriculture in GDP has been declining, while that of industry and services has been increasing. A fall in demand arising from a drop in agricultural incomes can be devastating if the bulk of industrial demand depends on it. However, if the non-agricultural economy is bigger and stronger and the demand for industry only slows down, then the impact is not so devastating.

When a drought hits incomes (either amongst farmers or amongst other households), the household tries to protect consumption by using savings or credit. Higher savings have given households greater power to smooth their consumption. The increase in household savings since the 1980s has led to a build-up of wealth, which allows households to smooth consumption even in bad years when their income declines, by dissaving.

The increase in the availability of retail credit to households in recent years has allowed urban households to borrow and spend irrespective of the rains, which helps sustain non-agricultural GDP. In addition, the export demand for manufacturing has added to the reduction in the dependence of industrial demand on Indian agriculture.

The result of the change in these patterns of growth is striking. The mean GDP growth rate has risen sharply. If we compute an average mean growth rate of GDP every year for the preceding 10 years, starting in 1961, we find that this rate has risen from a 3-4 per cent sluggish growth rate, often called the Hindu rate of growth, to over 5 per cent. Further, the volatility of the growth has gone down sharply. India is no longer subject to sharp ups and downs in production and income. While it is true that the monsoon will pull down growth, raise expenditure on drought relief and reduce tax revenue collection, but its impact will be limited. All the ills of the economy can no longer be placed at its door.

Traditional issues in agricultural policy — such as improving irrigation — are still necessary for reducing the vulnerability of agriculture to monsoons. But the growth of non-agricultural sectors, high household savings rates and access to credit have created conditions under which consumer demand does not dry up in a year of drought. Drought-proofing India critically hinges on obtaining high growth rates of industry and services. South Korea in 1960 was quite dependent on agriculture, but they are now an OECD country. Vagaries of nature do not destroy the economy. That is the way India has to go.

Ila Patnaik