MacroScan - The Growth Model has Come Undone

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 with 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 per annum for the period 2009/10-2011/12. The slowdown in fixed investment was even sharper, to 7 per cent per annum 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 the 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 protests 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.

* This article was originally published in the Hindu, 10 July, 2012.