It
was a remarkable coincidence that industrial growth slowed down drastically
when Congress rule ended and the BJP came to power in the 1990s. In this column
from the Telegraph of 21 October 2003, I explored the likely reasons.
SLOW AND
UNSTEADY
Industrial
growth is not determined by political regime alone
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It speaks for the political acumen of
the Congress that it has never taken credit for a remarkable difference
between its regime and the Bharatiya Janata Party’s: industrial growth
reached extraordinary heights under its government, and slowed down almost the
minute the Congress was voted out. The Reserve Bank of India, in its latest Report
on Currency and Finance, 2001-02, divides the last ten years into three
periods — Ia was the year between 1992-93 and 1993-94, Ib was the four years
from 1993-94 till 1996-97 and II was the four years from 1997-98 till
2001-02. Manufacturing grew at 6.3 per cent in Ia, 12.2 per cent in Ib, and
4.2 per cent in II. The slowdown is all the more galling when compared with
China’s uninterrupted industrial growth exceeding 10 per cent.
Growth is not determined by political
regime alone; and one thing leads to another. So it is strictly illegitimate
to make comparisons like the above. But in politics, anything goes; logic is
irrelevant, and any stick is good enough to beat the opposition. That the
Congress has not used this stick is because of the fact that it is proud
neither of its last prime minister nor of the economic reforms his government
carried out.This slowdown has attracted a number of explanations. The Reserve
Bank in its RCF holds four factors responsible:
1. Domestic savings ratio came down
because the government turned from net saver to dissaver; this is a polite
way of saying that the governments increased their fiscal deficits.
2. Savers developed an aversion to risk.
In Ib, they enthusiastically bought company shares. When many of the
companies failed to give returns, savers turned to the Life Insurance
Corporation and government financial institutions in II.
3. The investment ratio fell for a
number of reasons: because the savings ratio fell, world growth slowed down,
and domestic reforms lost momentum.
4. Incremental capital-output ratio
rose: investment resulted in smaller output increases.
The Reserve Bank’s explanation is
supply-based. If the savings ratio fell on its own, the multiplier would
rise, so would demand growth for a unit increase in investment, and at a
given rate of investment we would get higher real growth or higher inflation
or both — just the opposite of what happened. So the crux of the explanation
is the fall in investment which, together with the fall in capital
productivity, reduced the growth rate of productive capacity. But this
conclusion is inconsistent with the Reserve Bank’s own finding that the
output gap (capacity minus output) was negative before and positive after
1996-97 — that is, output rose faster than capacity till 1996-97 and less
fast than capacity after.
R. Nagaraj, in the Economic and
Political Weekly for August 30, reaches the conclusion that the
Reserve Bank should have reached with its own data, namely that industry was
supply-constrained till 1996-97 and demand-constrained after. He attributes
the fall in the growth of demand for industrial products to a fall in the
growth-rate of agriculture and in government investment.
The fall in agricultural growth was much
sharper than in industrial growth: it fell from 5 per cent in Ia to 4.6 per
cent in Ib and 1 per cent in II. The difficulty lies in the unimportance of
agriculture. It accounts for only a quarter of the gross domestic product;
and whilst the entire population spends about a quarter of its income on
industrial goods, the proportion for farmers is much less — perhaps half as
much. So it is difficult to give much weight to agricultural slowdown as the
cause of industrial slowdown.
Nagaraj supports Mihir Rakshit’s policy
conclusion — that the government should run larger deficits and spend more on
investment; Nagaraj favours investment in agriculture. This argument has a
certain appeal: agricultural growth-rate has fallen, so has public investment
in agriculture, so the latter should be raised to stimulate the former. The
huge stocks of foodgrains and sugar would suggest that agriculture is as
demand-constrained as industry and requires no further investment. But
Nagaraj would perhaps say that government purchases only keep foodgrain
prices up and rural purchasing power down: that if agricultural growth were
raised, government’s efforts to keep agricultural prices up would be defeated
and real agricultural prices would come down, real rural incomes would go up,
and villagers would buy more industrial goods.
The World Bank, in its July report (India:
sustaining reform, reducing poverty), points out something none of the
indigenes noticed: that there is strong negative correlation between combined
government fiscal deficit and private corporate investment. Its conclusion is
that after 1996-97, government borrowing crowded out corporate investment. It
also shows that as inflation fell sharply, the real interest rate rose: it
was close to zero till 1995-96, and around 5 per cent after that. Thus in its
view, the macroeconomic cause of the industrial slowdown is the rising fiscal
deficits after 1996-97.
The ratio of combined fiscal deficits to
GDP was 9.3 per cent in the crisis year of 1990-91. It came down to 7.2 per
cent in the following five years, and then rose to 9.3 per cent in the ninth
plan period (1996-97 to 2001-02). If the present trends continue, it will
rise to 11.1 per cent in 2003-04 and 13.1 per cent in 2006-07. The ratio of
interest costs to revenue will rise from 43.3 per cent to 54.7 per cent. The
debt to GDP ratio will rise from 86 per cent to 107 per cent.
The strong balance of payments has made
it possible for the government to run larger deficits in two ways. First, the
rising reserves have increased money supply, and made it possible for the
Reserve Bank to sell more debt and suck back the money from the economy — so
much debt in fact that it has rapidly depleted the government debt on its own
books. Second, it has enabled the Reserve Bank to reduce interest rates and
bring down the cost of servicing. But reserve accumulation may not continue.
In the World Bank’s view, much of the accumulation was due to hot money
running into India through non-resident Indian deposits following 9/11.
Western governments began to collect more information on hot money flows in
the hope of curbing criminal activities, and some of the money trying to
escape these probes came to India. It cannot continue to flow in; and if
economic growth revives as it has been doing in the past year, that will
further reduce reserve accretion.
I have noted in my earlier writings that
the slowdown has been accompanied by a large increase in non-corporate
savings as well as direct investment. In other words, businesses other than
corporates have been saving more out of their profits and reinvesting it. On
the other hand, Nagaraj has shown that the share of the unregistered sector
in fixed investment in manufacturing came down sharply after 1995-96. The
growth of manufacturing output too came down. Hence it is unlikely that the
higher non-corporate investment went into industry. It follows that it must
have gone into services, whose output has grown much faster than that of
industry. So I infer two related trends since 1996-97: deindustrialization
and decorporatization.
What accounts for them' The share of
services in GDP has gone up at the cost of industrial products: the share of
non-tradeables has gone up at the expense of tradeables. That suggests to me
rising overvaluation of the rupee. Thus in my view, the boom in software
exports led to a rise in reserves. The Reserve Bank reacted to reserve
accumulation by keeping rupee depreciation below inflation, and in the past
year by appreciating the rupee. This has made large sectors of manufacturing
industry internationally uncompetitive. Despite the rising level of
protection, their growth-rate has come down. Thus the industrial slowdown is
a clear case of Dutch disease.
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