India had a dream run of five years during 2003-08 as the GDP growth averaged nearly 9 per cent annually for five years, the best ever run over five years!

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ICRIER has been forecasting India's GDP growth rate with the use of  'Leading Indicators'.

For constructing the leading indicators index, the following ten indicators have been used: (i) production of machinery and equipment, (ii) sales of heavy commercial vehicles, (iii) non-food credit, (iv) railway freight traffic, (v) cement sales, (vi) sales of the corporate sector, (vii) fuel and metal prices, (viii) real rate of interest, (ix) BSE Sensex and (x) GDP growth rates of the US and Europe.

A composite index for the leading economic indicators has been constructed for the period 1997-2008 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.

Leading indicators could predict future growth based on what has already happened in the past but cannot capture the impact of sudden external shocks which may have an immediate impact on the economy.

The leading economic indicator index (LEI) 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 future GDP growth.

The estimated equation for GDP growth forecast is satisfactory with adjusted R-square value of 0.58 and t-values for the regression co-efficients of 3.24 for LEI (-5) and -5.95 for the shock variable, which are significant at 99 per cent level.

GDP Forecast for 2008-09 and H1 2009-10
	No Shock	With Shock
2008-09	7.5	5.8
H1 2009-10	6.8	3.9

As the chart shows, India would have grown 7.5 per cent this year (a slowdown from 9 per cent in 2007-08), had the global crisis not occurred.

The global crisis is likely to bring India's growth rate to below 6 per cent in 2008-09. With the first half GDP growth rate already known, this implies a sharp slowdown in the next two quarters.

In the first half of next year, the economy would have grown below 7 per cent in the absence of the external crisis. The global crisis may reduce Indian growth rate to as low as less than 4 per cent in 2009-10.

(However, we have not calibrated the intensity of the different shocks and the impact on growth is treated similar far all shocks. If the current shock is more serious than the previous ones, the growth may fall even further.)

The implications are significant. For starters, the Eleventh Five Year Plan targets should be recalibrated immediately if that exercise is to remain credible.

We should prepare the people for slowdown in employment generation and plan for counter cyclical measures urgently.
This should imply an immediate reduction in interest rates to bring down the cost of capital and a quick and thorough review of government procedures that vitiate the investment environment and hike up transactions costs.

Rather than throw more money at the problem, it is important to identify infrastructure projects like the highway programme where some additional resources but a lot of attention to implementation and execution can generate additional capacities and help raise growth. But some counter cyclical fiscal measures will surely have to be taken.

Perhaps one to be considered seriously is a cut in the central excise duties, as this will lower prices and bring forth new demand.  This will give greater strength to finance minister's demand for industrialists to reduce prices.

Policy makers have to deploy all tools at their command to boost business sentiment and consumer confidence which are both badly shaken. It is an extraordinary situation seeking extraordinary measures.

Additional reporting by M Joseph and K Singh

The authors are Director & Chief Executive, Senior Consultant and Consultant at ICRIER, respectively. The views expressed here are personal and not necessarily those of the organisation where they work.

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