“A major concern confronting Indian economy relates to the slowdown in growth witnessed in the last 5 years” said Dr. C Rangarajan, Former Chairman, Economic Advisory Council to the Prime Minister and Former Governor, Reserve Bank of India and presently the Chancellor of University of Hyderabad (UoH) while delivering the School of Management Studies (SMS) Foundation Day Lecture on 11 August 2017 at the Savitribai Phule Auditorium, UoH. He also said, “It is true that India’s growth even after slowdown has been one of the highest in the world. Nevertheless, the concern persists because the slowdown in growth has had an even greater impact on employment”.
“Job creation happens only when the momentum of high growth is maintained. We have shown that India has the potential to grow at 8 to 9 per cent in a sustained way”, Dr. Rangarajan added.
In his lecture titled ‘On Stepping up India’s Economic Growth’, Dr. C Rangarajan spoke on the ways to get back to the high growth rate. In his lecture he spoke on, the New Approach; Trends in the Growth; Determinants of Growth; Increasing Incremental Capital – Output Ratio (ICOR); Declining Investment Rate and the Way Forward.
Dr. Rangarajan also launched the MBA – Business Analytics programme after his lecture.
Prof. Appa Rao Podile, Vice-Chancellor, UoH presided over the function. Prof. B Raja Shekar, Dean, School of Management Studies gave the welcome address and briefed the guests and audience about the activities of the School of Management Studies.
Dr. D V Srinivas Kumar, faculty at SMS gave an overview of the MBA – Business Analytics programme.
Dr. Mary Jessica, Professor at SMS proposed the vote of thanks.
The function was attended by students, faculty, staff and guests from the city.
Dr. C Rangarajan’s Lecture
On Stepping up India’s Economic Growth
A major concern confronting Indian economy relates to the slowdown in growth witnessed in the last 5 years. It is true that India’s growth even after slowdown has been one of the highest in the world. Nevertheless, the concern persists because the slowdown in growth has had an even greater impact on employment. Job creation happens only when the momentum of high growth is maintained. We have shown that India has the potential to grow at 8 to 9 per cent in a sustained way. What can then be done to get back to the high growth rate? This lecture is addressed to find some answers to this question.
The New Approach: Break with the Past
In the post-Independence economic history of India, the year 1991 is an important landmark. The country faced a severe economic crisis, triggered largely by a serious balance of payments problem. The crisis was converted into an opportunity to effect some fundamental changes in the content and approach to economic policy.
There is a common thread running through all the measures introduced since July 1991. The objective is simple: to improve the efficiency of the system. The regulatory mechanism involving multitudes of controls has fragmented capacity and reduced competition even in the private sector. The thrust of the new economic policy is towards creating a more competitive environment in the economy as a means to improving the productivity and efficiency of the system. This is to be achieved by removing the barriers to entry as well as the restrictions on the growth of firms. While the industrial policy seeks to bring about a greater competitive environment domestically, the trade policy seeks to improve international competitiveness, subject to the protection offered by tariffs which are themselves coming down. The private sector is being given a larger space to operate in, as some areas earlier reserved exclusively for the public sector are now also allowed to the private sector. In these areas, the public sector will have to compete with the private sector, even though the public sector may continue to play the dominant role. What is sought to be achieved is an improvement in the functioning of the various entities, whether in the private sector or the public sector, by injecting an element of competition in them. There is, however, nothing in the new economic policy which takes away the role of the state or the public sector in the system. The New Economic Policy of India has not necessarily diminished the role of state; it has only redefined it, expanding it in some areas and reducing it in others. As has been said, somewhat paradoxically, more market does not mean ‘less government’ but only ‘different government’.
The break with the past has thus come in three important directions. The first was to dismantle the complex regime of licences, permits and controls that dictated almost every facet of production and distribution. Barriers to entry and growth were dismantled. The second change in direction was to reverse the strong bias towards state ownership of means of production and proliferation of public sector enterprises in almost every sphere of economic activity. Areas once reserved exclusively for the state were thrown open to private enterprise. The third change in direction was to abandon the inward looking trade policy. By embracing international trade, India signalled that it was boldly abandoning its export pessimism and was accepting the challenge and opportunity of integrating into the world economy.
The policy environment in India has undergone a drastic change in the last two decades. The objective of this policy change is to create an environment in which firms will be compelled to improve productivity and reduce costs. In a highly protected environment, there was no incentive for firms to cut costs. Very often they operated under a `high margin-low volume’ syndrome. The initiative to adapt and improve technology or to undertake research and development effort also dried up. The reform process that has been underway is basically an approach and broadly the approach to any area has been in terms of improving productivity and efficiency.
Trends in Growth
That the economic reforms India undertook have been on the right track is vindicated by the performance of the economy since the launch of reforms. In the post-reform period beginning 1992-93, the economy has grown at an average rate of 6.8 per cent per annum, a significant improvement over the pre-reform period.
India’s annual growth rate between 1952 and 1980 averaged to 3.5 per cent. With population growing almost at 2.2 per cent, the average annual growth rate of per capita income was 1.3 per cent. It is true that the Indian Economy grow between 1980 and 1990 at 5.6 per cent. But the economy faced the worst crisis in 1991-92 and the growth rate fell to 1.0 per cent. It is extremely doubtful if without a change in the strategy of development, growth would have picked up again.
Economic growth in the ten-year period beginning 2005-06 despite the crisis affected year of 2008-09 was at an average rate of 7.7 per cent. Between 2005-06 and 2007-08, the economy grew at an annual rate of 9.4 per cent. However, economic growth has slowed down from 2012-13 and it is to this issue I turn now.
CSO’s provisional estimates indicate that the growth rate of GDP for 2016-17 will be 7.1 per cent as against 8.0 per cent in 2015-16. The growth rate of GVA at basic prices in 2016-17 will be 6.6 per cent as against 7.9 per cent in 2015-16.
The decline in the growth rate as mentioned earlier is not a recent phenomenon. It started in 2011-12. The persistence of relatively low growth over a five year period calls for a critical examination. Even though the new numbers on national income give us some comfort, they do not tell the whole story.
Determinants of Growth
Ultimately, the growth rate is determined by two factors – the investment rate and the efficiency in the use of capital. As the Harod-Domar equation puts it, the growth rate is equal to the investment rate divided by the incremental capital – output ratio. The incremental capital – output ratio (ICOR) is the amount of capital required to produce one unit of output. The higher the ICOR, the less efficient we are in the use of capital. There are many caveats to this bald proposition. As we look at the Indian performance in the last five years, two facts stand out. One is a decline in the investment rate and the second is a rise in ICOR; both of which can only lead to a lower growth rate.
Increasing ICOR
As growth was coming down sharply initially, the investment rate was falling only slowly, implying a rising ICOR. ICOR is a catch-all expression which is determined by a variety of factors including technology, skill of man-power, managerial competence and also macro-economic policies. Thus delays in the completion of projects, lack of complementary investments in related sectors and the non-availability of critical inputs can all lead to a rise in ICOR. The Economic Survey of 2014-15 reported that there were in all 746 stalled projects with 161 in the public sector and 585 in the private sector with a total value of Rs. 8.8 lakh crore. As of 2015-16, there were still 404 stalled projects, 162 in the public and 242 in the private sector with a total value of Rs. 5.5 lakh crore. In the short run the biggest gain in terms of growth will be by getting `stalled projects’ moving. Of course some of them may be unviable because of changed conditions. A periodic reporting by the government on the progress of stalled projects will be of great help.
Declining Investment Rate
India’s investment rate reached a peak in 2007-08 at 38.0 per cent of GDP. With an ICOR of 4, it was not surprising that the growth rate was close to 9.4 percent. One sees a steady decline in the investment rate since then. The decline in the rate was small initially but has been more pronounced in the last two years. According to the latest estimates the Gross Fixed Capital formation rate fell to as low as 27.1per cent in 2016-17. With this investment rate, it is simply impossible to achieve a growth rate in the range of 8 to 9 per cent.
The major issue confronting us is: why did the investment rate fall? Why are not new investments forthcoming? In 2011 and 2012 in discussions on the Indian economy, the one phrase that used to be bandied about was ‘policy paralysis’, pointing to the inability of the government to take policy decisions because of ‘coalition compulsions’. It is true that around this period, the government was preoccupied with answering many issues connected with graft. But that does not explain the steady fall in the investment rate except for a sense of uncertainty created in the minds of investors.
The external environment was also not encouraging. The growth rate of the advanced economies remained low and the recovery from the crisis of 2008 was tepid which had an adverse impact on exports. However, India benefited by large capital inflows except in 2013. For almost three years beginning 2010, India also had to cope with a high level of inflation which also had an adverse impact on investment sentiment. Once the growth rate starts to decline, it sets in motion a vicious cycle of decline in investment and lower growth. The acceleration principle begins to operate. We need to break this chain in order to move on to a higher growth path.
Way Forward
What are the solutions, given the current situation? The standard prescription, whenever private investment is weak, is to raise public investment which can take a longer term view. This standard suggestion is very much appropriate in the present context as well. In the best of times, public investment has been 8 per cent of GDP. The central government’s capital expenditures even after some increase in the last two years, is only 1.8 per cent of GDP. About 3 to 4 per cent of GDP comes from public sector undertakings and the balance from state governments. What is needed now is for the public sector undertakings to come out with an explicit statement indicating the extent of investment they intend to make during the current fiscal. And this intention must be monitored every quarter and this will inspire confidence among prospective private investors.
The critical question is, however, to enhance private investment and that too private corporate investment. During the high growth phase, corporate investment reached the level of 14 per cent of GDP. Since then it has fallen. In fact, a recent study shows that the total cost of projects initiated by corporate sector has come down from Rs. 5560 billion in 2009-10 to Rs. 954 billion in 2015-16. This continuing trend must be reversed. Three things need attention. First, reforms to simplify procedures, speed up the delivery system and enlarge competition must be pursued vigorously. Some significant steps have been taken in this regard in recent years such as the passage of the GST Act, passing of the Bankruptcy Act and enlarging the scope of Foreign Direct Investment. Second, all viable ‘stalled’ projects must be brought to completion. Third, the financial bottlenecks need to be cleared. The banking system is under stress. The non-performing loans of the system have risen and are rising. This has squeezed the profitability of banks with some showing loss. More distressing is the minimal flow of new credit. The problem is often referred to as the twin balance sheet problem. If corporate balance sheets are weak, automatically the banks’ balance sheets also become weak. Really speaking, it is two sides of the same coin. The solution to clean up the balance sheet of banks lies in taking some ‘haircut’. At least some part of the accumulation of bad debts has been due to the slowdown of the economy. The old saying is “bad loans are sown in good times”. Even though haircut cannot be avoided, willful defaulters must not go unpunished. Asset restructuring companies are part of the solution and we have some experience of them.
This is also the appropriate time to revive an idea which had withered away during the reform process and that is to have institutions focused on long term lending such as IDBI and ICICI as they were before 1998. The details can be worked out. But the idea needs a rethink.
Conclusion
In many ways the coming decade will be crucial for India. If India grows at 8 to 9 per cent per annum, it is estimated that per capita GDP will increase from the current level of US$1,600 to US$ 8,000 by 2030. Then India will transit from being a low income to a truly middle income country. We need to overcome the low growth phase as quickly as possible, as growth is the answer to many of our socio-economic problems. In the recent period, we have launched a number of schemes aimed at broadening the base of growth. These include the employment guarantee scheme, universalisation of education, expansion of rural health, and providing food security. All these programmes have made a substantial demand on public expenditure. It has been possible to fund these programmes only because of the strong growth that we have seen in recent years. Growth has facilitated raising more resources by the Government.
Development has many dimensions. It has to be inclusive, it must be poverty reducing, and it must be environment-friendly. We need to incorporate all these elements in the growth process. A strong and balanced growth will enable the economy to achieve multiple goals including reducing poverty. India has to follow a twofold path of accelerating growth and addressing directly through various schemes the vulnerable and poor groups.
Investment, as they say, is an act of faith in the future. If there has to be investment resurgence, it is necessary to create the climate which promotes this faith. We have already outlined the actions that can be taken in the purely economic arena. But ‘animal spirits’ are also influenced by what happens in the polity and society. Avoidance of divisive issues is paramount in this context. Undiluted attention to development is the need of the hour.