Unsustainable import competition and the end of the investment
subsidy that the sale of under-priced resources provided to Indian
companies are the main reasons why the economy has slowed down
What has been called the ‘golden age’ of India’s economic growth was
underpinned by global integration, high rates of investment and savings
growth and low current account deficits. The slowdown is characterised
by a sharp deceleration in investment growth on the demand side and in
agriculture, manufacturing and construction on the supply side,
alongside high and unprecedented current account deficits.
The government’s argument that this is the result of the global economic
slowdown and related uncertainty is only partly true. The deeper
reason, which the government is either unwilling or unable to come to
grips with, is the unravelling of the underlying growth model — partly
due to structural change engendered by globalisation and partly because
the investment subsidy implicit in under-pricing assets is no longer
feasible.
Imports
The speed and depth of global integration accelerated sharply in the
first decade of the 21st century. The average international trade
(exports+imports) ratio which for the period 1992/3-94/95 stood at 19
per cent rose to 27 per cent by 2000/01-02/03. However by 2008/9-2010/11
this ratio had shot up to 48 per cent. But in this phase of rapid
integration import elasticities — of both total imports as well as
non-oil imports — have more than doubled. As a result, even as GDP
growth has decelerated, goods export growth has slowed faster than both
total goods import and non-oil import growth, resulting in a widening
current account deficit, given that service sector exports growth
dropped off as well.
This increasing import dependence has affected the three major sectors
asymmetrically because their integration into the global economy is very
different. Manufacturing is the economy’s most integrated sector, with
an average trade ratio for the period 2008/9-2010/11 of 180 per cent.
For agriculture and services this stood at less than 20 per cent. Even
if we consider the sub-sector ‘financial and business services’, its
trade ratio was only 58 per cent . For manufacturing, both the pace and
nature of its integration changed significantly in the first decade of
the 21st century.
The manufacturing sector’s trade ratio in 1994/95 was 92 per cent. By
2000/01-2002/03 the ratio had risen to 112 per cent with the import
ratio slightly higher than exports. This increase pales into
insignificance as compared with that of the next decade when the average
manufacturing trade ratio had risen to 180 per cent, with export and
import ratios at 68 and 112 per cent. Therefore not only has integration
increased sharply for the manufacturing sector but it has also been
asymmetric — import penetration has almost doubled whereas export
integration has increased by 20 per cent.
Of the three sectors, however, manufacturing is the only one that runs a
trade deficit. The deficit is substantial, the average for the period
2008/09-2010/11amounting to 44 per cent of manufacturing GDP and rising —
the average was only 9 per cent for the period 2000/01-2002/03. Little
wonder then that, in the face of continuing import competition,
manufacturing growth has witnessed a sustained slowdown. And, as one
would therefore expect, capacity utilisation has declined significantly,
well off its third-quarter 2009/10 peak, as Reserve Bank of India
surveys indicate.
Investment growth
One of the more remarkable aspects of the ‘golden age’ was that demand
growth was investment-led, both in absolute and relative terms. In
constant terms, over the period 2003/4-2007/8 gross investment grew at
17 per cent per annum, more than twice the rate of private consumption
expenditure. What is historically unprecedented was that gross
investment accounted for more than 50 per cent of demand growth at the
margin. If the high growth phase was investment-led, so is the slowdown.
Investment (gross) growth slowed down to 10 per cent p.a. for the
period 2009/10-2011/12. The slowdown in fixed investment was even
sharper, to 7 per cent p.a. over the same period, less than 50 per cent
of that in the high-growth phase. The depth of the deceleration is
brought home by the fact that in 2011/12 gross and fixed investment grew
only at 5.8 and 5.6 per cent respectively. And, more worryingly,
consumption has decelerated much less and, as a result, over the last
couple of years, it has grown faster than investment, resulting in the
decline of the critical investment-to-consumption ratio.
Some part of investment slowdown surely has to do with the asymmetric
increase in the integration of the manufacturing sector where import
levels have increased five times faster than export levels. In other
words, manufacturing growth has become very import dependent. The
adverse effects of this dependence have become apparent with the global
slowdown. Increased import competition now slows down sales growth of
domestic firms, reduces capacity utilisation, puts pressure on margins
and adversely affects expected profitability of the sector. The pressure
on expected profitability affects investment in manufacturing. This in
turn drags down overall investment growth given the under-appreciated
fact that the sector accounts for the largest proportion of investment
in the economy.
Under-priced assets
If the nature and pattern of integration has affected investment growth,
Keynesian ‘animal spirits’ have been dampened due to a factor quite
unrelated to globalisation.
During both the NDA and UPA-I regimes, an important driver of investment
growth has been access to undervalued assets, whether those of the
public sector, mineral and forest resources, land or the ability to
influence the allocation of scarce spectrum resources. During the NDA
regime, privatisation of public sector assets at fire sale prices
stalled in the face of widespread political and social opposition. With
privatisation off table, the UPA-I chose to use all other modes listed
above to ensure that animal spirits were kept in ruddy health. The
investment boom of the ‘golden age’, which roughly coincides with the
UPA-I term, therefore, was primed by access to a wide variety of
undervalued assets, ranging from land (SEZs, PPP infrastructure, etc.)
to spectrum.
In UPA-II, however, this dynamic has largely run aground, hemmed in by
protests from below and corruption scandals. Widespread and sustained
protest against the public acquisition of land for private purposes —
Singur, Nandigram, POSCO, Jaitapur, just to name an iconic few — has
made it a political hot potato which is to be re-legislated and at least
for the moment is off-limits. The implementation of the Forest Rights
Act (FRA) and introduction of new legislation to govern the distribution
of benefits from mining suggests that mining leases may not be as easy
to get nor as lucrative as earlier. Add to this the Niira Radia
revelations, the 2G scandal, the Anna Hazare movement, the CAG’s
observations and Supreme Court rulings and it is not easy (at least as
of the moment) to use elite access to influence the underpricing of
assets. Therefore, all mechanisms used during UPA-I to under-price
assets and give animal spirits a sufficiently conducive environment have
become infructuous, being caught up in unintended political economy
consequences.
Finally, there is one other aspect of the slowdown that has had an
impact on market growth, expected profitability and investment.
Construction is one of the three sectors that has borne the brunt of the
slowdown. As we know from the last large sample survey of the NSS, over
this phase of jobless growth, the two sectors that did produce jobs
were construction and business services. The slowdown in construction
will therefore have had consequences for employment growth, slowing down
domestic demand growth just when external markets have dried up, again
adversely affecting expected profitability and investment.
The nub, therefore, is that the investment-led growth model of the
‘golden age’ has come undone and like Humpty Dumpty, the PM’s men and
women cannot put it back together again. The undoing is only partly the
result of the global financial crises and the related slowdown. There
are two other important reasons which the government does not talk
about: globalisation has led to unsustainable import competition in the
manufacturing sector, leading to a slowdown in manufacturing growth and
hence in investment; second, the investment subsidy implicit in the
under-pricing of assets in high demand is no longer feasible due to
political economy reasons. As C.P. Chandrasekhar
has articulated in earlier columns, it is of course possible to chart
an alternate path and revive growth and investment. For that we would
need to stop genuflecting before the fallen gods of finance capital. But
that was too much to expect of the former finance minister or of the
incumbent. There is, then, little else to do but to wait for the
monsoons, capricious foreign investment or other such manna from heaven.
(The author teaches economics at IIM Calcutta. Email: mritiunjoy@gmail.com)
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