The Economy 21
evidence on the cyclical properties of consumption is not available. However,
we may hazard some conjectures. Consumption smoothing requires financial
depth through possession of liquid wealth such as securities, and it requires
credit access. At present, most households lack both kinds of tools for con-
sumption smoothing. Hence, it is likely that consumption in India is more
sensitive to the business cycle than in countries like the United States and
the UK.
From first principles, economic growth comes from changes in labor, capital
and productivity. The discussion above has brought out strengths on all three
Demographics, education and learning-by-doing are generating a process
of improvements in labor.
Capital is characterized by a rising savings rate, improved access to for-
eign savings, and a market-dominated financial system with information
processing done through speculative markets.
Finally, improvements in infrastructure, rationalization of the role of the
State in the domestic economy, reducing barriers to trade and height-
ened competition between competent firms are key drivers of productivity
India is hence in a remarkable situation where there is a positive outlook on
all the three ingredients that go into growth: labor, capital, and productivity
(Kelkar, 2004b). This suggests that the trend GDP growth rate will further
accelerate in the future. However, the present state of knowledge does not permit
numerical estimates of either the date or the magnitude of this acceleration.
GDP growth seems to involve growth cycle fluctuations about a long-term trend
GDP growth rate, which, in turn, has been steadily accelerating. In order to
measure this phenomenon, we create a ten-year moving average of GDP growth,
in order to eliminate some of the distracting noise in the growth cycle.
Years of negative GDP growth were observed in the past, and were invariably
associated with a drought. The reduction of the share of agriculture in GDP
For a business cycle perspective on Indian macroeconomics, see Shah (2008).
22 India’s Financial Markets
1960 1970 1980 1990 2000
10–year mean growth
10–year volatility
FIGURE 1.8 Ten-Year Moving Average Growth and Its Volatility
has led to a diminished importance of such issues. Fluctuations away from the
trend were largely driven by agriculture in the earlier years; in recent decades
the drivers have been modern phenomena like investment and inventory
fluctuations of firms.
In understanding the evolution of GDP, it is particularly interesting to look
at the ten-year moving average and standard deviation of annual GDP growth,
to get at the underlying long-term trends (see Figure 1.8). This evidence high-
lights two main facts. First, from roughly 1979 onward, the trend in GDP
growth has accelerated from 3.5%. Second, the volatility of GDP growth has
dropped sharply. In 1980, India was a low-mean, high-variance macroeconomy.
Over the years, it has increasingly become a high-mean, moderate-variance
The most recent values suggest that the mean or trend GDP growth is around
6.2% with a cycle around it which has a standard deviation of roughly 1.9
percentage points. It appears fair to think that under “normal business cycle
fluctuations,” GDP growth will not drop below 4.5%. Growth below 4.5% would
require a currency crisis or a political crisis. This reasoning suggests that while
the economy will be growing at good rates, this will not be growth at a steady,
unvarying rate. The economy will definitely witness cycles in growth rate. Busi-
ness cycles in the Western sense of the term are unlikely to be found since the
probability of negative GDP growth is negligible. The growth cycle is affected
by both local factors and the global business cycle.

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