When
GDP growth bounced back to close to 9 per cent after
the slump induced by the global recession, India’s
growth performance once again appeared remarkable
by global comparison. But one feature that has sullied
this record is evidence of a deceleration in industrial
growth in recent months. Month-on-month annul growth
rates which stood at between 10 and 18 per cent during
most months of the August 2009 to July 2010 period,
have since decelerated and stood at less than 5 per
cent in four of the five most recent months (September
2010 to Jan 2011) for which data are available (Chart
1). As a result, even though annual rates of growth
are still respectable (Chart 2), some disquiet has
been expressed in various circles.
Chart
1 >> Click
to Enlarge
It
is useful to view the recent downturn as being part
of longer-term trends in industrial growth. Unfortunately,
since IIP figures have been recompiled from April
2004 onwards, using the new series of WPI to deflate
IIP items for which production is reported in value
terms, fully comparable month-on-month rates of growth
are available only from April 2005. But examining
this series (Chart 2) points in two directions. The
first is that the recent downturn is sharper than
the one experienced during the immediately preceding
cycle. Second, while the previous downturn may have
begun earlier, it stretched across the period that
saw the onset of the global financial crisis and witnessed
the global recession. On the other hand, the more
recent downturn has occurred in a period when the
recession had bottomed out and the world economy was
experiencing a recovery.
Chart
2 >> Click
to Enlarge
One inference that could be
drawn from this is that it is not so much an export
recovery as developments in the domestic market that
underlie the deceleration in industrial growth. This
is of significance because, as Chart 2 illustrates,
if we take a long view, after a mini-boom during the
mid-1990s, industrial growth remained low for most
years during the 1996-97 to 2002-03 period. After
that, growth recovered and reached a peak in 2006-07.
And, if we exclude 2008-09, which was a year of slow
growth induced by the global recession, it appears
that Indian industry had subsequently settled into
a trajectory of growth of around 8 to 9 per cent a
year. What the recent slowdown does is question the
sustainability of that manufacturing growth trajectory.
The sustainability issue is all the more relevant
because of the concentration of post-2004 growth in
a few industrial sectors. Consider for example an
analysis in which the contribution of each of 17 two-digit
industry groups to aggregate manufacturing growth
during April 2004 and January 2011 is computed. This
is done by multiplying by the trend rate of growth
of the relevant group with its weight in the index
of manufacturing production. The resulting figure
shows that that there are only five of these seventeen
that contributed at least 5 per cent of the observed
growth in manufacturing over this period. These five
were all metal- or chemical-based and included: (i)
Manufacture of Basic Chemicals and Chemical Products
(except products of petroleum and coal) (Group 30
of National Industrial Classification 1987); (ii)
Manufacture of Rubber, Plastic, Petroleum and Coal
Products (Group 31); (iii) Basic Metal and Alloys
Industries (Group 33); (iv) Manufacture of Machinery
and Equipment Other than Transport Equipment (Group
35-36); and (v) Manufacture of Transport Equipment
and Parts (Group 37). These five out of 17 industry
groups accounted for as much as 58.5 per cent of the
total growth in the index of manufacturing production
(Chart 3).
Chart
3 >> Click
to Enlarge
This concentration of growth
in the metal- and chemical-based industries has a
number of possible implications. The most obvious
of these stems from the fact that the metal- and chemical-based
industries tend to be among the more capital intensive
in the industrial sector. Employment per unit of investment
or output in these industries is much smaller than
in many other manufacturing sectors. Hence, if growth
is biased in favour of the metal- and chemical-based
industries, the responsiveness of employment in the
manufacturing sector to a unit increase in manufacturing
output would be lower than would otherwise be the
case. Growth could be jobless or inadequately job
creating. This has indeed been a feature characterising
registered manufacturing growth in India in recent
years.
But there could be implications for the nature of
growth itself. To start with, inasmuch as it is domestic
demand that drives growth in these industries, that
demand would in all probability be fuelled by (i)
public expenditure, particularly public investment,
which tends to be biased in favour of demand for these
industrial products; (ii) upper income group consumption
of such commodities that are normally not ''necessities'';
and (iii) debt-financed household investment (in housing),
purchases of automobiles and consumption of ''luxuries''.
These are the kinds of demands for final products
that tend to be directed at the metal- and chemical-based
industries. Hence, growth based on such industries
would depend on the availability of one or more of
these sources of demand as stimuli for the industrial
sector.
Besides being driven by demands of these kinds, these
industries are normally in the nature of clusters,
in the sense that the metal- and chemical-based industries
are dependent on inputs from similar industries and
serve, if at all, as inputs for downstream metal-
and chemical-based industries. This results in the
fact that growth or deceleration in these sectors
tends to be ''cumulative''. If exogenous demand trends
induce a slowdown of growth in some of these industries,
they have a dampening effect on the growth of related
industries as well.
These two features of growth, in turn, have implications
for the sustainability of the growth process. If growth
is to continue, one or more of these sources of demand
must remain strong. There are limits to the degree
to which upper income demand can continue to sustain
growth, since even though incomes are high in this
group, the share of the population included is extremely
small. Hence, public expenditure and debt-financed
investment and consumption have to be sustained.
A feature of fiscal reform policy has been an attempt
by the government to rein in deficit spending by reining
in expenditures. This tendency has been stronger because
tax policy reform in recent years has focused on the
reduction of customs duties as part of trade liberalisation,
on a reduction of direct taxes to incentivise private
saving and investment, and of indirect taxes as part
of a process aimed at rationalising them. As a net
result the tax-GDP ratio has been significantly lower
than would have been the case if these changes had
not been made. A corollary is that for any given reduction
of the fiscal deficit, the expenditure-reduction required
tends to be higher than would have been the case earlier.
Thus, the more successful is fiscal reform in terms
of tax and deficit reduction, the larger would be
the relative reduction in public expenditure.
From the point of view of industrial growth, therefore,
the successful implementation of fiscal reform implies
a transition to a deflationary fiscal environment
with dampened demand. It is possible that it is this
effect that explains the slowdown in industrial growth
in the period between the mid-1990s and 2003-04 (Chart
2). But that does raise the question as to the factors
underlying the subsequent recovery in industrial growth.
That recovery cannot be attributed to a reversal of
fiscal reform, except for the period after the onset
of the downturn induced by the global recession in
2008, when the government responded with a fiscal
stimulus that was adopted also because of the parliamentary
elections scheduled for April-May 2009.
Thus, during much of the period of high growth after
2003-04, the stimulus to industrial growth in all
probability came from debt-financed private investment
in housing, private purchases of automobiles and private
consumption. Growth based on debt-financed demand,
however, requires the continuous expansion of the
universe of the indebted. While enhanced availability
of cheap liquidity and financial innovation that can
bundle and distribute risk can encourage such expansion,
at some point the threat of unsustainable defaults
would slow, if not stop, the process. That would slow
demand growth as well. This is perhaps what explains
the evidence of the decline of the month-on-month
growth rates of the indices of manufacturing and industrial
production after March 2007, which was before the
global recession and well before its effects were
felt in India.
Once the effects of the recession were felt, industrial
growth slumped. It was the response of a government,
with an eye to the impending elections, to that slump,
that led to the recovery and return to high growth.
But the fiscal stimulus encouraged by the election
was a once-for-all effort on the part of a government
that was committed to fiscal conservatism. When it
returned to power it chose to unwind the stimulus.
It is because that unwinding process was not accompanied
by any neutralising surge in debt-financed private
investment and consumption that we have witnessed
over the last fiscal a significant deceleration in
month-on-month growth rates in industrial production,
which now appears to be quite steep. It is indeed
too early to conclude with confidence that this is
what is happening. But that seems to be an argument
that explains trends in industrial growth over the
medium term. If so, we can expect that we are set
for a return to a period of slower industrial growth
as happened in the second half of the 1990s. Unless
once again, some other stimulus, such as exports,
provides the basis for growth.
