The Telegraph
Tuesday , January 24 , 2012
Since 1st March, 1999
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- Why has investment been doing so badly?

Economies expand and shrink. As for the Indian economy, it is unusual to shrink; but its growth rate does go up and down. On why it does so, economists have strong ideas: that what people spend on consumption depends on their incomes, and that other kinds of expenditure — by governments, by businesses — can vary independently of the incomes.

These independent variables determine the ups and downs of gross domestic product; this is the core of Keynesian theory, which even anti-Keynesians accept.

Estimates of national income or product are inevitably approximate, and subject to error; their estimators sensibly measure national income in three ways, and thus also get an estimate of the errors, which they openly disclose. Sometimes, the errors and omissions are close to zero; in the second quarter of 2010, for example, they were a mere Rs 4,000 crore. The figure looks large to those of us who have just begun to count in lakhs, but it was less than a quarter per cent of the domestic expenditure of over Rs 17 lakh crore. A year earlier, it was a speck of dust — a mere Rs 49 crore. Government statisticians have greater trust in second-quarter figures than any other, because that is when the government, in course of preparing its budget, makes an accurate count of its own figures, and while doing so, of its citizens’ accounts.

According to their figures, national expenditure at constant prices in the third quarter of 2011 was some 6 per cent above the expenditure a year earlier. National expenditure in the third quarter of 2010 was some 9 per cent above the expenditure a year earlier than that; in one year, the growth rate had fallen by about a third. The reason lay in the fall of investment — capital expenditure, as official statisticians call it — in constant prices, it fell absolutely between the third quarters of 2010 and 2011. The share of investment in national income was 31 per cent two years ago, and 27 per cent in the last quarter; in two years it had fallen by 4 per cent. That is highly improper for an economy that the world looks towards as the saviour in the ongoing global downturn.

Why has investment been doing so badly? Investment is costly; businessmen have to find money for it, out of their profits, by borrowing, or by selling shares. There are other uses for that money, so businessmen do not usually use it for investment unless they expect good profits. Maybe they looked at the state of the world, decided that it was too depressing, and cut their risks. Or maybe they would have gone on investing merrily, but could not find the money. What was the case? Krittika Banerjee, a clever researcher resident in the tower of the Reserve Bank of India, has tried to discover the answer. I have a problem with the answer, but that does not take away from the excellence of her figure work.

According to her figures, Indian businesses became considerably more dependent on bank credit in financing their investment in the past 10 years. In 2000-01, public limited companies got about a third of their investment funds from banks; eight years later, they got about two-thirds. Private limited companies — that is, companies that are not quoted on stock exchanges — had less luck, but the share of bank credit in their finance also rose from some 40 per cent to 65 per cent. This is the decade which saw gross domestic product growth rising to 9 per cent; all that growth owed much to bank credit.

Manufacturing led in this increasing dependence on banks; the ratio of their loans to value added in manufacturing — that is, the sum of its wages and profits — rose from some 50 per cent to 75 per cent over the decade.

But it was not the only insatiable borrower. The same ratio rose from some 10 per cent to 30 per cent for agriculture, and some 10 per cent to 20 per cent for services. This ratio is not quite the right one to look at, for loans do not finance value added; they finance business liabilities. But the point is made that businesses financed their growth by resorting to bank loans.

Banerjee runs sophisticated statistical tests to show the changing relationship between banks and business. According to her, between 1951 and 1980, banks chased businesses, and their loans influenced business growth. Between 1981 and 1990, there was no correlation between the two. After 1991, growing businesses sought out bank loans, and bank credit followed business growth. My understanding is slightly different. The period from 1951 to 1980 is broadly that of socialist planning. Then, small business was unimportant, and the government controlled the growth of big business through industrial and import licensing. Licensing protected businesses against competition. A company could go nowhere without licences; once it got licences, it could go to a bank and tell it, “Look! I have got a licence to print money. If you would give me a loan, you can be sure you will get a good return.” Once the loan was given, growth followed.

This regime changed after the oil crises of the 1970s. Oil producers made huge profits and parked them in international banks. Private businesses were simply not large enough to be able to borrow such enormous amounts. So, international banks lent to Latin American countries. India was socialist and anti-American, so it did not qualify. But by the 1980s, the Latin American countries had gone bankrupt. In the meanwhile in India, the Hindu growth barrier of three-and-a-half per cent was broken, Indira Gandhi was defeated and dumped, and Rajiv Gandhi had ambitions for India. As productivity started growing faster, companies started making profits, and could do without bank money. Short of borrowers, banks gave money to speculators like Harshad Mehta. After 1991, businesses continued to finance their growth mostly out of profits. But when their growth outpaced their capacity to finance, they ran to banks; banks financed excesses of growth.

Bank nationalization of 1969 also played a part in this story. It led to politicization of bank lending. Private businesses could no longer rely on banks, so they developed other sources. That is why correlation between business growth and bank lending broke down in the 1980s. The bad debts, or non- performing assets to use officialese, were bundled into Asset Reconstruction Company (India) Limited in the late 1990s. Banks were relieved of them and could start lending again, so correlation between business growth and bank lending came back.

What will happen next? Another cycle is inevitable. The great industrial boom of 2004-09 has collapsed, and manufacturing output has declined absolutely in recent months. This downturn must lead to defaults on bank loans; NPAs will rise. The State Bank of India, India’s largest bank, is already in a crisis. Others may be, but we will not learn soon because the RBI would not like such bad news to come out. But it cannot be kept secret for long because it will show in banks’ balance sheets. At that point, our finance minister will step in, take money out of our pockets, and bail out improvident banks. Socialism continues to live.