New issues in Indian macro policy.

Figure 1 Agriculture/GDP ratio

2.3.1 Monsoon shocks matter less

In the India of old, there was no conventional business cycle (Patnaik and Sharma, 2002).
A good year was one with a good monsoon and a downturn was generally about a bad
monsoon. These developments played out over a short horizon of one or two years. Output
fluctuations significantly reflected a succession of uncorrelated monsoon shocks - it was not
a conventional business cycle.

A major change in the behaviour of the Indian macroeconomy, then, consists of the
rapidly dropping importance of agriculture. As Figure 1 shows, the share of agriculture in
GDP has dropped quite sharply from 27% in 1996-97 to 17.5% in 2006-07.

In addition, the vulnerability of agriculture to the monsoon is declining through the
spread of irrigation. The linkages between agriculture and the economy are weaken-
ing. Putting these factors together, the domination of monsoon shocks in influencing
the macroeconomy has been substantially attenuated.

Linearly extrapolating into the future, agriculture may drop below 10% of GDP by
2013, by which time it would be an essentially insignificant part of Indian macroeconomics.
Agriculture will stop mattering for macroeconomics; within a few years, it will be just
another industry.

2.3.2 A more conventional business cycle

In recent years, large fluctuations of inventory and investment of firms have taken place, in
line with the mainstream notions of a conventional business cycle that is found in mature
market economies.

Several factors are at work here. In the old world, firms did not have operational flex-
ibility to invest. Firms were static, with fixed technology and minute product variation

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