It speaks for the political acumen of the Congress that it has never taken credit for a remarkable difference between its regime and the Bharatiya Janata Party’s: industrial growth reached extraordinary heights under its government, and slowed down almost the minute the Congress was voted out. The Reserve Bank of India, in its latest Report on Currency and Finance, 2001-02, divides the last ten years into three periods — Ia was the year between 1992-93 and 1993-94, Ib was the four years from 1993-94 till 1996-97 and II was the four years from 1997-98 till 2001-02. Manufacturing grew at 6.3 per cent in Ia, 12.2 per cent in Ib, and 4.2 per cent in II. The slowdown is all the more galling when compared with China’s uninterrupted industrial growth exceeding 10 per cent.
Growth is not determined by political regime alone; and one thing leads to another. So it is strictly illegitimate to make comparisons like the above. But in politics, anything goes; logic is irrelevant, and any stick is good enough to beat the opposition. That the Congress has not used this stick is because of the fact that it is proud neither of its last prime minister nor of the economic reforms his government carried out.This slowdown has attracted a number of explanations. The Reserve Bank in its RCF holds four factors responsible:
1. Domestic savings ratio came down because the government turned from net saver to dissaver; this is a polite way of saying that the governments increased their fiscal deficits.
2. Savers developed an aversion to risk. In Ib, they enthusiastically bought company shares. When many of the companies failed to give returns, savers turned to the Life Insurance Corporation and government financial institutions in II.
3. The investment ratio fell for a number of reasons: because the savings ratio fell, world growth slowed down, and domestic reforms lost momentum.
4. Incremental capital-output ratio rose: investment resulted in smaller output increases.
The Reserve Bank’s explanation is supply-based. If the savings ratio fell on its own, the multiplier would rise, so would demand growth for a unit increase in investment, and at a given rate of investment we would get higher real growth or higher inflation or both — just the opposite of what happened. So the crux of the explanation is the fall in investment which, together with the fall in capital productivity, reduced the growth rate of productive capacity. But this conclusion is inconsistent with the Reserve Bank’s own finding that the output gap (capacity minus output) was negative before and positive after 1996-97 — that is, output rose faster than capacity till 1996-97 and less fast than capacity after.
R. Nagaraj, in the Economic and Political Weekly for August 30, reaches the conclusion that the Reserve Bank should have reached with its own data, namely that industry was supply-constrained till 1996-97 and demand-constrained after. He attributes the fall in the growth of demand for industrial products to a fall in the growth-rate of agriculture and in government investment.
The fall in agricultural growth was much sharper than in industrial growth: it fell from 5 per cent in Ia to 4.6 per cent in Ib and 1 per cent in II. The difficulty lies in the unimportance of agriculture. It accounts for only a quarter of the gross domestic product; and whilst the entire population spends about a quarter of its income on industrial goods, the proportion for farmers is much less — perhaps half as much. So it is difficult to give much weight to agricultural slowdown as the cause of industrial slowdown.
Nagaraj supports Mihir Rakshit’s policy conclusion — that the government should run larger deficits and spend more on investment; Nagaraj favours investment in agriculture. This argument has a certain appeal: agricultural growth-rate has fallen, so has public investment in agriculture, so the latter should be raised to stimulate the former. The huge stocks of foodgrains and sugar would suggest that agriculture is as demand-constrained as industry and requires no further investment. But Nagaraj would perhaps say that government purchases only keep foodgrain prices up and rural purchasing power down: that if agricultural growth were raised, government’s efforts to keep agricultural prices up would be defeated and real agricultural prices would come down, real rural incomes would go up, and villagers would buy more industrial goods.
The World Bank, in its July report (India: sustaining reform, reducing poverty), points out something none of the indigenes noticed: that there is strong negative correlation between combined government fiscal deficit and private corporate investment. Its conclusion is that after 1996-97, government borrowing crowded out corporate investment. It also shows that as inflation fell sharply, the real interest rate rose: it was close to zero till 1995-96, and around 5 per cent after that. Thus in its view, the macroeconomic cause of the industrial slowdown is the rising fiscal deficits after 1996-97.
The ratio of combined fiscal deficits to GDP was 9.3 per cent in the crisis year of 1990-91. It came down to 7.2 per cent in the following five years, and then rose to 9.3 per cent in the ninth plan period (1996-97 to 2001-02). If the present trends continue, it will rise to 11.1 per cent in 2003-04 and 13.1 per cent in 2006-07. The ratio of interest costs to revenue will rise from 43.3 per cent to 54.7 per cent. The debt to GDP ratio will rise from 86 per cent to 107 per cent.
The strong balance of payments has made it possible for the government to run larger deficits in two ways. First, the rising reserves have increased money supply, and made it possible for the Reserve Bank to sell more debt and suck back the money from the economy — so much debt in fact that it has rapidly depleted the government debt on its own books. Second, it has enabled the Reserve Bank to reduce interest rates and bring down the cost of servicing. But reserve accumulation may not continue. In the World Bank’s view, much of the accumulation was due to hot money running into India through non-resident Indian deposits following 9/11. Western governments began to collect more information on hot money flows in the hope of curbing criminal activities, and some of the money trying to escape these probes came to India. It cannot continue to flow in; and if economic growth revives as it has been doing in the past year, that will further reduce reserve accretion.
I have noted in my earlier writings that the slowdown has been accompanied by a large increase in non-corporate savings as well as direct investment. In other words, businesses other than corporates have been saving more out of their profits and reinvesting it. On the other hand, Nagaraj has shown that the share of the unregistered sector in fixed investment in manufacturing came down sharply after 1995-96. The growth of manufacturing output too came down. Hence it is unlikely that the higher non-corporate investment went into industry. It follows that it must have gone into services, whose output has grown much faster than that of industry. So I infer two related trends since 1996-97: deindustrialization and decorporatization.
What accounts for them' The share of services in GDP has gone up at the cost of industrial products: the share of non-tradeables has gone up at the expense of tradeables. That suggests to me rising overvaluation of the rupee. Thus in my view, the boom in software exports led to a rise in reserves. The Reserve Bank reacted to reserve accumulation by keeping rupee depreciation below inflation, and in the past year by appreciating the rupee. This has made large sectors of manufacturing industry internationally uncompetitive. Despite the rising level of protection, their growth-rate has come down. Thus the industrial slowdown is a clear case of Dutch disease.