MacroScan - The RBI's Assessment of Indian Economic Reforms (contd.)

It is only the services sub-sectors, described in Charts 7 to 10, that suggested any increase in rates of growth, and that is primarily why GDP growth in the aggregate has remained respectable. Even here, however, financing, insurance, real estate and business services registered a significant slowdown. Also, the acceleration in output growth of community, social and personal services may not reflect a real increase so much as the increase in public sector wages that occurred over this period because of the Pay Commission awards.

Chart 10 >> Click to Enlarge

What explains this general deceleration in output growth in most sectors? The RBI report suggests that this reflects the more significant slowdown that has occurred after 1996, and therefore breaks down the post-reform period into three sub-periods for more detailed consideration.

Chart 11 gives some idea of this. It is clear that agricultural deceleration was the most advanced, with GDP growth in agriculture in the final five-year period averaging only 1 per cent per annum. But even manufacturing shows a sharp slowdown, falling in the last five years to only 4.2 per cent per annum-one of the lowest trend rates of growth experienced for Indian manufacturing in any period since the 1950s.

Chart 11 >> Click to Enlarge

The stability of services growth over this period was clearly inadequate to counter these recessionary trends, which is why the period 1997–98 to 2002–03 also shows aggregate GDP growth at a lower rate of 5.3 per cent.

Over this later period, savings rates also declined on average. Chart 12 indicates that this was primarily due to the collapse of public sector savings, as the public sector became a net dissaver. Indeed, savings was kept afloat essentially by the household sector, since private corporate savings also declined as a share of GDP over this period.

Chart 12 >> Click to Enlarge

Chart 13 takes a closer look at the distribution of household financial savings over the various five-year periods since the early 1980s. A number of features emerge from this chart. Currency has been declining as a share of total household financial savings, while more secure financial instruments have been gradually increasing. These include life insurance funds and net claims to the government (the so-called 'small savings').

Chart 13 >> Click to Enlarge

Significantly, bank deposits have been growing in proportion throughout this period. Stockmarket instruments-shares and debentures-increased in the early 1990s, but after the stockmarket scam, households clearly decided to stick to less risky forms of saving. By the last sub-period they accounted for only 5 per cent of household financial instruments. The swing away from such stockmarket instruments clearly seems to have benefited small savings in the last period.

Investment rates also declined on average in the last sub-period, as illustrated by Chart 14. Interestingly, the decline in investment showed both public and private sector investment deceleration, while the household sector actually increased its investment (which is the same as its physical savings). This is but another reflection of the increasing slack, or unemployment and underutilization of resources, in the macroeconomy, that has already been mentioned.

Chart 14 >> Click to Enlarge

Public sector investment was constrained by the falling tax–GDP ratios and the official perception that fiscal deficits needed to be contained, which meant cutbacks on public capital expenditure. There is no surprise in the associated decline in private corporate investment rates-the strong positive link between public and private investment in India (and indeed in most developing countries) is by now well-established, and the fact of recessionary tendencies in the economy during this period is also widely accepted.

The slowdown in manufacturing deserves closer attention. As Chart 15 shows, such deceleration was spread across a very wide range of manufacturing sub-sectors. So much so that only five sub-sectors appear to have bucked the adverse trend: beverages and tobacco, textile products, leather, chemicals and rubber, plastics petroleum and coal. For most of traditional manufacturing, as well as for the range of capital goods industries, the falls in growth rate were actually quite steep.

Chart 15 >> Click to Enlarge

The RBI report considers at some length the various hypotheses advanced to explain the deceleration. It mentions the argument that has been advanced by Macroscan earlier, that the slowdown reflected the satiation of pent-up demand once the initial spurt of import-intensive production had dealt with post-liberalization consumer demand. Once that once-for-all increase had been catered to, manufacturing faced a recession in the absence of any further demand impetus, either from the domestic economy or through exports. This was aided by the fact that the initial early 1990s' expansion had not greatly increase employment, and so had limited linkage and multiplier effects.

The RBI appears to reject this argument, on the grounds that 'the huge capacity build up noticed in the first phase of reform runs counter to the monetary surge in demand that was not likely to be sustained in the long run' (pages III–30). However, this counter-argument is weak at best, and is actually contradicted by the data provided in the very same report, on capital goods production and import. It will be seen from Chart 16, that both domestic production and imports of capital goods really increased in the middle of the 1990s, and peaked by 1997–98, when the onset of domestic recession from 1996 finally dampened investor expectations. Since then, both production and imports of capital goods have been relatively depressed, indicating that investor expectations have yet to recover in the absence of any stimulus either from the government or from the external sector.

Chart 16 >> Click to Enlarge

In addition, the report argues that the fall in government investment does not per se provide a satisfactory explanation of the slowdown, since government productive expenditure also declined during the short-lived boom. But that is precisely the point: that after that initial import-led consumption boom was over, the slowdown in government investment made things worse because there was no additional stimulus to private investment.

In contrast, the other explanations that have been offered for the manufacturing slowdown, which are apparently taken more seriously by the report, are almost laughable. The first relates to the 'credit crunch' faced by the corporate sector during 1995–96, when the RBI made large dollar sales to contain foreign currency market volatility. This could hardly explain the continued depression in investment until 2002–03. The important point about the credit market, which is not made in the report, is that the reduced access of small-scale industry to formal credit after financial deregulation has dramatically weakened its position and contributed substantially to the slowdown.

Similarly, the report argues that 'the proportion of corporate funds locked up in inventories and receivables went up steadily, leading to a scarcity of working capital' (pages III–30). This argument surely mistakes cause for effect-the increase in inventories is typically a sign of recession, not a factor determining it.

The report also mentions the role of cyclical factors, such as the lagged effect of low agricultural growth and the depressed international economic context. What it fails to mention is that it is precisely in such circumstances that expansion must come from government expenditure.

This reflects the basic constraint within which the report has been written, that it is operating very much within the paradigm of the marketist neo-liberal reform that the policy-makers in the Finance and other ministries have adopted. In the circumstances, it is hardly surprising that the Report is unable, despite its apparent intentions, actually to offer an objective assessment of the Indian reform experience.