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Insights into Editorial: Time for course correction

Insights into Editorial: Time for course correction



Data released by the Central Statistics Office (CSO) showed the economy grew 5.7% in April-June, the first quarter of the current fiscal year, slower than the previous quarter’s 6.1% and much lower than the 7.9% growth registered in the first quarter of 2016-17.

The real growth of GDP, i.e. after removing the impact of inflation, was only 5.7%, much lower than expected. This steady declining trend in the growth rate is a matter of concern.

What accounts for the decline in growth rate by almost 2 percentage points?

The slower growth is due to the decline in inventories ahead of the rollout of GST combined with the Demonetisation exercise. The rate has come down predominantly due to pre- GST effect as manufacturers were focusing more on clearing the existing stock.

Chief statistician of India said rising cost of intermediate goods and inventory deaccumulation in anticipation of GST implementation led to manufacturing growth falling sharply. Though he expects a revival in the second and third quarters as manufacturers normalise their stock positions subject to how well they have integrated with GST.

The most disappointing aspect of the first quarter numbers is the steep fall in the growth rate of manufacturing to 1.2%. Because of the good monsoon, agriculture will do better. Since agricultural growth rate last year was also good, the increase may not be that much.

Sharp decline in growth rate noted in the last few quarters cannot be attributed to poor export performance.

Growth is fuelled broadly by two types of demand, domestic and external.

  • High export growth has propelled the growth rate of many countries, including China’s. In India’s own experience, the high growth phase between 2005-06 and 2007-08 saw exports growing at an average annual rate exceeding 20%.
  • India’s declining growth rate has also coincided with poor export performance. Export demand has been weak because of the tepid growth rate of the advanced economies.
  • Both in 2014-15 and 2015-16, the export growth rate was negative. However, the export growth rate has become positive since the second half of 2016-17.
  • While undoubtedly export demand is critically important to sustain high growth, the sharp decline in growth rate noted in the last few quarters cannot be attributed to poor export performance. In fact, as compared to the previous year, the export performance has improved.

The fundamental problem has been the sharp fall in the investment rate

GFCF(Gross fixed capital formation) is a measure of gross net investment (acquisitions less disposals) in fixed capital assets by enterprises, government and households within the domestic economy, during an accounting period such as a quarter or a year.

In India, Gross fixed capital formation rate stood at 34.3% in 2011-12. This started falling steadily and touched 29.3% in 2015-16. It fell further to 27.1% in 2016-17.

  • According to the latest numbers, in the first quarter of 2017-18, it stood at 27.5%.
  • Since the public investment rate has not shown any decline (it stands at 7.5% of GDP), it is the decline in private investment, both corporate and households, that has been responsible for the steady fall.
  • While the fall in corporate investment is steep compared to what was achieved in 2007-08, it has more or less stabilised at a lower level of around 13%.
  • Household investment has continued to decline even in recent years. Household here includes not only pure households but also unincorporated enterprises.

Declining growth rate and its effect on employment

Jobless growth is an economic phenomenon in which a macro economy experiences growth while maintaining or decreasing its level of employment. Deep concerns have been expressed about the fact that the growth that we have seen in recent years has not resulted in an increase in employment.

It may be noted that data on employment are not very reliable. Firm data are available only for the organised sector. The rest are estimated through surveys. In fact, in the case of unorganised sectors, very often the position is one of ‘underemployment’ rather than unemployment.

Growth can occur because of two reasons. One, it results from better utilisation of existing capacity. Two, it can come out of new investment. Whatever growth we have been seeing recently has come out of better utilisation of capacity rather than new investment. It is real growth spurred by new investment that generates more jobs.

Falling investment rate

Investment, which is between 30 and 35% of the total pie, needs to grow at least in double digits. Investment in future capacity creates GDP growth of the future. It needs to be led by the private sector. Currently, that component is barely growing at 1.5%. As a result, capital formation is steadily declining for several years. Private sector investment has practically come to a standstill. Despite the push for ‘Make in India’, reforms for improving ‘Ease of Doing Business’, increased access to electricity, improvement in infrastructure and private investment are not picking up.

Another interesting factor about the falling investment rate is that the last few years have shown a steady and substantial increase in foreign direct investment (FDI). FDI inflows in 2016-17 were at an all-time peak of $60 billion. In the first quarter of 2017, the inflows were $10.9 billion. With this type of inflow and if the investment rate has not grown, the one inference that one can make is that much of the FDI has gone into acquiring old assets rather than going to Greenfield projects. All this implies is that domestic investors continue to remain shy.

What can be done to stimulate private investment?

  • First, in creating an appropriate investment climate, reforms play an important role. Some of the noteworthy changes that have happened in the last few years are the passing of the bankruptcy code and GST legislation, and modifications in FDI rules. We must continue with the reform agenda and there is still a lot to be done in the area of governance.
  • Second, financing investment has taken a beating because of the poor health of banks. Banks in India today are universal banks providing both short-term and long-term credit. The sharp reduction in the flow of new credit has also put prospective investors in a difficult situation. To resolve the non-performing asset (NPA) problem and to bring banks back to good health, recapitalisation has become urgent.
  • Third, a close look must be taken at stalled projects to see what can be done to revive those which are viable. This must be part of an overall effort to hold consultations in small groups with investors to understand and overcome the obstacles that come in the way of new investment. Industry-by-industry consultations and analyses are needed to pinpoint problems and their solutions.
  • Fourth, even though the progress of small and medium industries is very much dependent on the fortunes of the large, a separate look at medium and small enterprises may be needed to prod them into new investment.


The growth rate in 2017-18 is unlikely to exceed 6.5%. Perhaps in the coming quarters we may see a rebound. Once the glitches and fears of the GST are over, the growth rate may pick up. Our goal must be to achieve and sustain a growth rate of 8% and above over an extended period and what we need is an immediate stimulus to re-inject the momentum.  That will crucially depend on a big pick-up in manufacturing and private investment spending.

However, there has been a slight pick-up in public investment recently. That is not enough. Only when the two engines of public and private investment function at full throttle will India fly high.

The big structural reforms of GST, the new insolvency code, the new monetary framework and Aadhaar linkage are measures which will show results in the medium to long term.