The high growth in industrial output since July 2009 and the positive export growth from November 2009 have substantially altered the outlook on the Indian economy for 2009-10. The finance minister is now reported to have raised the GDP growth forecast for the year to eight per cent. Researchers at ICRIER have looked at the latest data and have re-estimated our growth forecasts.

Separate forecasts have been worked out for the agricultural and non-agricultural sectors.  The weighted average of growth in the two sectors yields forecasts of aggregate GDP.

Agricultural GDP Growth: Impact of Monsoon Failure

In 2009-10, rainfall was severely deficient in the months of June and August. The overall rainfall deficiency during the monsoon was 23 per cent. The last time the country experienced a severe monsoon failure was in 2002-03. Agricultural value added declined by 8.1 per cent that year, bringing down the GDP growth rate by about two percentage points. Are we likely to see a similar decline this year or will the significant improvement in the monsoon during the latter half of the season substantially mitigate the effects of the shortfall during the first half of the season? Unlike in 2002-03, when the 19 per cent deficit in the monsoon was spread throughout the season, the monsoon revived strongly this year in the second half of August, although there was rain deficiency in the last three weeks of September. Besides, post-monsoon rainfall has been good news for the rabi crop, and during October-December, rainfall has been eight per cent above normal.

ICRIER researchers had forecast agricultural growth for 2009-10 on the basis of an agricultural growth model in October 2009 (ICRIER Working Paper No. 241). The model has three variables: (1) the deviations of rainfall from normal, (2) the net sown area and (3) the last three-year moving average of agricultural growth. The model was estimated for the period, 1990-91 to 2008-09. 

The first two variables, viz., rainfall and net sown area, capture the shock resulting from the failure of the monsoon. The lagged, three-year moving average of growth in agriculture captures the limits to growth in India’s agriculture due to capacity constraints.

Based on the latest information on the progress of agricultural cropping, we have assumed a three to four per cent fall in the net area sown for the entire year. This is based on two factors. First, the estimates of area under kharif crops indicate a fall of 5.4 percent compared to that last year. Second, rabi area sown so far up to mid-December 2009 is 1.8 per cent up from the previous year.

The agricultural growth rate is forecast to fall by 2.3 to 4.2 per cent (Chart 1).  Agricultural value added will fall by 2.3 per cent if the net area sown declines by three per cent and fall by 4.2 per cent if the net area sown declines by four per cent. This will mean that GDP will decline by 0.4 to 0.7 percentage points in 2009-10 due to the poor monsoon.

Chart 1. Forecast of Agricultural Growth (%) 2009-10

Non-agricultural GDP Growth    

We have used the leading economic indicators (LEI) approach to forecast non-agricultural GDP growth. The set of leading economic indicators are:  (i) production of machinery and equipment (ii) non-food credit (iii) railway freight traffic (iv) cement sales (v) net sales of the corporate sector (vi) fuel and metal prices (vii) real rate of interest (viii) BSE sensex and (ix) exports. A composite index has been constructed for the period 1997-2009 with the quarterly series of growth of these variables (except for the real rate of interest where the level, and not the growth, has been used) using the ‘principal component index’ (PCI) method. The advantage of PCI is that it performs the required scaling of data and assigns weights to different indicators. The PCI method assigns weights to each component leading indicator by an iteration process based on its contribution to total variation in the composite index.

The leading economic indicator index (LEI) given in Chart 2 below clearly shows that after moving down from the first quarter of 2006-07, LEI bottomed out in the first quarter of 2009-10 and has started moving up thereafter.

Chart 2: Leading Economic Indicators Index

Source: Computed based on data from various Government of India departments, Reserve Bank of India, Bombay Stock Exchange and CMIE.

Once the index of leading indicators is available, it is used to identify the appropriate model specification for the final regression analysis. In this empirical exercise, it was found that the index of leading economic indicators (LEIs) with a 5-quarter lag explains the variation in non-agricultural GDP growth most precisely. However, since the selected leading indicators do not capture the impact of external shocks such as the IT boom burst in 2000-01 and the current global crisis, which directly or indirectly impacted the Indian economy, we used a dummy variable to capture their impact.  The LEIs, with a 5-quarter lag and the shock represented by a dummy variable (equal to 1 with shock and 0 without), are used to forecast India’s non-agricultural GDP growth. The estimated equation for non-agricultural GDP growth forecast, given below, is satisfactory with an adjusted R-square value of 0.58 and all the co-efficients significant at 99 per cent level.

It appears that the three fiscal stimulus packages have moderated the intensity of the impact of the global crisis on India’s GDP growth. The shock-augmented leading indicator model validates this. The in-sample forecast suggests that the crisis had started impacting non-agricultural GDP growth partially in the third quarter of 2008-09 before having its full impact in the fourth quarter. The fiscal measures taken during December 2008 to March 2009 began to moderate the intensity of the shock in the first quarter of the current financial year. It seems likely that the impact of the shock will fully be neutralised from the third quarter especially because monetary policy measures are also expected to make their impact felt with theual time lag. With these assumptions, we estimate that the non-agricultural GDP would grow by 8.7 per cent in 2009-10.

Non-agricultural growth has been 7.9 per cent in the first half of 2009-10. The growth of 8.7 per cent for the full year implies a growth of 9.5 per cent in the second half of 2009-10, reflecting the strong growth in industrial production in recent months.

Table 1 brings together the forecasts for both agricultural and non-agricultural sectors. The estimated aggregate GDP growth for 2009-10 works out to between 6.5 and 6.8 per cent, which is around the actual growth of 6.7 per cent in 2008-09.

Table 1: GDP forecast for 2009-10