The Hindu : An incomplete economic recovery

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Saturday, Aug 16, 2003

Opinion

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An incomplete economic recovery

By C. Rammanohar Reddy

While the economic recovery this year is encouraging, it may turn out to be a one-off event unless the Government is able to catalyse a quantum increase in investment.

THIS TIME last year, the outlook for the economy could not have been bleaker. It was apparent that agricultural production in 2002-03 was going to be affected and that the Central Government would have to focus on drought relief for drinking water, fodder and rural employment. There was no question of the economy doing well. A year later, the situation is dramatically different. The economic outlook could not be brighter. Monsoon 2003 has been excellent so far; only two of the 36 meteorological zones in the country have received less than normal rainfall. The rains have been plentiful and production of a variety of crops — cereals, oilseeds, cotton, sugarcane, fruits and vegetables — will yield a huge harvest in 2003-04. It should not be surprising if total grain production in both the kharif and rabi seasons crosses the record 212 million tonnes produced in 2001-02.

The spurt in agricultural production that can be expected in this fiscal year will give a momentum to output in industry and services as well. To add to the good news, it was only a brief and small spike in inflation that took place just after the war on Iraq. Tax collections have been by and large on target. And we no longer see the large foreign exchange reserves (more than $80 billion) with the Reserve Bank of India as anything exceptional. All told, we should see the economy grow by well above 6 per cent in 2003-04.

Pleased we may well be with the economic recovery this year, but the expected acceleration in GDP growth in 2003-04 should be kept in perspective. One should not, for now, read too much into the economic bounce we can expect during the rest of the year. The recovery may turn out to be a one-off event unless the Government is able to catalyse a quantum increase in investment.

The first thing to remember is that when a "normal" year follows a "drought" year, a substantial jump in the GDP growth rate always takes place. This was the case right through the 1960s and the 1970s, when agriculture accounted for 50 per cent and more of GDP, and it has been so during the past 20 years as well, even as agriculture's share in GDP has gradually shrunk to under 30 per cent. The years 1983-84, 1988-89 and 1992-93 all saw a major pick-up in the growth rate. Common to all of them was the fact that they followed years of a contraction in agriculture. More recently, GDP growth almost doubled in 1998-99 and 2001-02, which came after years when the output of the primary sector (agriculture, forestry and fishing) had fallen. So when 2003-04 ends with GDP growth much more than the 4.3 per cent registered in 2002-03, it would be good to keep in mind that the acceleration is no achievement of any kind. It is only to be expected.

Whether or not the turnaround in 2003-04 will herald the arrival of a new phase of high growth over the medium term depends less on the immediate beneficial impact of the monsoon on the economy and more on what happens to domestic investment. Since 1997-98, gross fixed capital formation (investment in production-generating assets in agriculture, industry and services) has consistently ruled at under 22 per cent of GDP. This contrasts with the situation between 1990-91 and 1996-97, when, other than two years, this indicator of investment was well over 22 per cent. It is this decline in investment in recent years which has been responsible for the slowdown of GDP growth from 1997-98 onwards. The extent of slowdown is not always recognised. The simple average of the annual growth rate of the gross national product (GNP) was 6.8 per cent between 1992-93 and 1996-97; this average came down to 5.3 per cent between 1997-98 and 2002-03. One good or even excellent monsoon is not by itself going to end this broad deceleration.

Investment has declined because outlays by the public sector (Central and State Governments and public sector enterprises) have plunged in recent years. And investment by the private sector (corporates, unorganised sector and households), which was expected to compensate for the decline in public sector investment, has instead stagnated. The fiscal reforms attempted through the 1990s have had their repercussions in the form of a relative decline in capital expenditure. However, this decline did not take place mainly during the first half of the 1990s, when the fiscal reforms began. The decline has been more marked from the second half of the 1990s onwards. Gross fixed capital formation as a proportion of GDP fell from 9 per cent to around 8 per cent during the period 1990-91 to 1994-95. But since then the fall has been dramatic. By 2001-02 (the latest year for which information is available) investment in the public sector had come down to as little as 5.9 per cent of the GDP. Clearly, even the considerable expenditure that has been incurred on the National Highway Development Project has not been enough to neutralise the relative fall in investment in power, irrigation, petroleum and telecom, all sectors that were earlier the mainstay of public sector investment.

The trends in private sector investment have been disappointing, to say the least. After rising from around 13 per cent of GDP in the early 1990s to a shade under 17 per cent of GDP in 1995-96, private capital expenditure has slumped and remained at under 16 per cent since 1996-97. The stagnation in private investment has been on account of a number of factors. New capital outlays in the small-scale sector in manufacturing have almost stopped taking place because of the gradual removal of reservation, inadequate credit, decimation by imports, and competition from the organised sector. The exception is in sectors oriented towards exports, but minimal outlays appear to be taking place in these areas. In the corporate sector, sluggish domestic demand and the fear of competition from imports have led to a drying up of investment in industry. It is only in services and the household sector that a measure of investment has been taking place.

Will the many-faceted bounty of the 2003 monsoon change any of this? In the short-run, the step up in growth that the economy is going to witness will arise from the better use of production capacity. In agriculture, fields which did not receive rainfall or could not be irrigated last year will yield much more. In industry, manufacturers who have been running their units at less than full capacity will ramp up production. In the service sector, providers of a host of services who have been complaining of a slump in retail demand will see business grow in 2003-04. But how far will the economic agents in all three sectors be persuaded that this is not a short-term phenomenon and that they should therefore step up fixed investment?

It is possible that private investment in industry, especially in manufacturing, will see a revival. The present spell of buoyancy in the capital market, if it lasts, will encourage outlays. The fear of imports still haunts industry but the China syndrome that seemed to weaken confidence in the late 1990s has largely disappeared. Both should push investment in industry. At the same time household capital expenditure should also grow. It will be driven by a "feel-good" factor and fuelled by easy credit, though there is a risk that the credit-driven splurge will suddenly result in a sharp increase in bad debts. If, on the whole, an optimistic assessment points to a revival of private investment in industry, the same cannot be said about public sector investment. The public sector enterprises are being affected by policy uncertainty and Government indifference. This is most evident in petroleum and telecom. And less said the better about capital expenditure by the Centre and the State Governments. The States have long since given up any serious attempt to channel funds into avenues of productive investment in agriculture and infrastructure. The Centre, on the other hand, is long on promises but is always short on action. A good example is the promise the Centre made in the last budget to fuel investment in infrastructure. We all remember the headlines about the so-called "public-private partnerships" that would give a new impetus to investment in power, ports and roads. As we approach the half-way mark in the fiscal year 2003-04, we do not see any indication of these programmes taking off. Capital expenditure in the public sector is therefore not going to increase to any measurable extent in the near future.

On balance, there are no clear signs that the economy is going to build on the recovery of 2003-04. There is only one certainty, that the present fiscal year will see GDP growth well above 6 per cent. That is good news, but the Indian economy needs more than a year of high growth facilitated by plentiful rains.

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