Given the bleak external environment, high inflation, high interest rate and declining corporate investment, analysts are increasingly speculating that the days of 9 per cent growth rate in India are over.
India posted a growth rate of 6.5 per cent in 2011-12. GDP data for the last three quarters (6.1 per cent, 5.3 per cent, and 5.5 per cent) add substance to their claim.
Has sub-6 per cent become the new India story? To what extent are high fiscal deficit and high rates of interest responsible for slowing GDP growth rate? Will the interest rate cut be enough?
High cost of funding has led to postponement of capital expenditure by the private sector in an unfavourable external environment.
Interest rate sensitivity
Many argue that over the years, because of the growing share of retail and housing loans, interest rate sensitivity of domestic consumption expenditure has increased.
GDP growth is thus constrained from both sides (demand and supply) by high rates of interest. Therefore, the solution lies in reducing the fiscal deficit and lowering interest rate to let the investment pick up and bring the growth rate back to 8-9 per cent.
Analysis of RBI data shows that there is not much correlation between low interest rate and investment.
The real rate of interest in the boom period (2003-08) was very high (7 per cent), but private sector remained more or less bullish, as it was confident of recovering its investment in an overall optimistic environment — domestic as well as external.
In 2011-12, it is quite low (3.8 per cent), yet investment is not picking up. Many corporate and public sector companies are sitting on a stockpile of cash balances. Availability of funds, thus, cannot be the problem. Yet, investment rate is declining.
Then what is causing the slowdown in investment and GDP growth? Is it an unfavourable external environment? Are we as dependent on Europe and the US as we used to be a decade ago?
Besides, should not the weakened rupee help India’s export price competitiveness?
Seventy per cent of India’s exports are now going to regions other than Europe and the US. Only a few sectors such as garments and IT & ITES have high exposure to troubled EU and the US. However, decline in the rupee somewhat compensates these export setbacks.
What explains slowdown?
A business-unfriendly regulatory regime and poor infrastructure, by adding to the cost of doing business, are hampering private sector investment in a bleaker external environment. Rampant corruption, slower approvals and high interest rates further add to the woes of the Indian corporate sector.
India fares badly on most indicators, ranging from starting a business, to paying taxes, to export-import formalities (see table). When it comes to facilitating business in South Asia, India is better than only Afghanistan and Bhutan. On some indicators, such as enforcing contracts, India is almost at the bottom.
This reduces India’s attractiveness as a preferred investment destination, despite the obvious advantages of large domestic market and low dependency ratio.
An increase in Incremental Capital Output Ratio (ICOR) to 5.1 per cent in the Eleventh Plan from 4.2 per cent in the Tenth Plan tells the story of India’s inefficiency. Poor state of transport and logistics in India is another key hindrance.
According to the Transport Corporation of India Ltd, the average speed of a truck in India is 21 km/hour. India’s road network is growing 4 per cent against a traffic growth rate of 11 per cent per annum.
Cross-subsidisation of railways passenger fares by increasing freight charges (along with scarcity of rail racks) is pushing shipment of merchandise to overburdened roads, and adding to the already high logistics cost.
Poor availability and high cost of labour (in comparison to productivity) is hampering growth of manufacturing sector.
Average labour cost in India is almost equal to China, even though Chinese per capita income is roughly thrice that of India.
To deal with rising wages and restrictive labour laws, manufacturers are increasingly resorting to contract labour. The result is some workers get less pay for the same job, leading to discontent and violent clashes.
Despite the rhetoric, the share of manufacturing in India’s GDP has remained constant around 15-16 per cent since 1960s.
Unless India’s manufacturing becomes lean and cost-efficient, booming domestic consumption will not be of much help and the sector will continue to be hit by imported goods from low cost countries, with adverse consequences for output and employment.
Restrictive policies, growing rural wages and low productivity have shackled India’s farm sector.
Growth of services is constrained by slowdown in EU and the US, underperforming primary and secondary sectors of the economy and relative scarcity of skilled labour.
The way out
In the short run, reduction in interest rate will help rate-sensitive sectors such as automobiles, infrastructure and housing. Disinvestment of PSUs can be resorted to, to ramp up public investment, preferably in infrastructure, to make up for a substantial fall in corporate investment.
An expenditure switch from subsidies to investment is the need of the hour. Increased public investment will induce investment from private sector if accompanied by policy actions to resolve coal, land and power bottlenecks.
Indian businesses (in addition to tapping domestic market) will have to look beyond EU and the US, in particular to Africa, CIS, Latin America and neighbouring SAARC for growth.
Removing restrictions on inter-state trade will help India leverage its economic size and diversities when the country’s traditional export markets are in crisis.
However, in the long run, there is no alternative to improving the quality of regulation and basic infrastructural facilities, ranging from railways to roads, ports and power, in order to improve India’s comparative cost advantage.
Here, one must not underestimate the responsibility of States that need to play their part in bettering regulation and infrastructure in their respective jurisdictions.
At present, 0.25 per cent of India’s GDP is spent on R&D with half of it coming from the private sector.
This must go up if Indian businesses want to meet competition from low-cost countries such as Bangladesh or China in domestic as well as third country export markets.
(The author is Group Economist of a corporate house. Views are personal.)