Tracing Patterns in Industrial Growth: Business Standard: 29th December 2008

The primary factors driving industrial growth are investment and foreign trade growth, not growth in capital issues, foreign investment or the Sensex, says Madan Sabnavis
The negative growth in industry in the month of October has caused umbrage as this is the first time in over a decade that we have actually witnessed a decline in industrial growth. Add to this the decline in exports and the picture is quite disheartening. Several reasons have been offered for the lower rates of growth in industry. Some of them are lower consumption levels, investment, government expenditure, trade and so on. On the other hand, policy measures have been invoked to redress the same.
The purpose here is to take an impassioned view of the relationships between industrial growth and certain variables for which we have a priori reason to believe that there could be a relationship between the two. Therefore, we can look at, say, the growth in consumption, which theoretically would be related with industrial growth as it provides critical demand to stimulate growth. The coefficient of correlation between the two could be looked at for the last 18 years to ascertain whether or not the two are related. This way one can see whether there is prima facie a relationship between high industrial growth and these variables. The coefficient of correlation, it must be remembered, only says whether there is directional relationship and does not talk of causation. Hence, while we all know that high industrial growth causes GDP growth, the number per se only says that in the last 18 years, the thought that high industrial growth was associated with high GDP growth was good.
Tables 1 and 2 give the correlation coefficients between industrial growth rate and other variables where the relationship was significant and not-so-significant. For a set of 18 observations (ie, after reforms set in), a significant coefficient would be above 0.44.
Table 1 shows that the top 5 variables that have a strong correlation with industrial growth are growth in imports, exports, GDP, level of FII and growth in bank credit. While imports and exports are definitely linked with industry as imports are used for industrial production while exports prospects feed back into demand stimulus for industry, the same cannot be said about FII investments. For both FII and FDI levels, it may be said that higher industrial growth affects these levels in terms of foreign flows into the country either in the secondary market or as investment. The same holds for the Sensex and capital issues, where the level would be related with industrial performance. Growth in the services sector can be linked inexorably with that in manufacturing as organised services such as finance, transport, communication and trade would need positive impulses from the industrial growth front. Further, while higher growth in credit is another pre-requisite for industrial growth, inflation is not.
Table 2 however is more revealing as it goes at times against the grain of common perception. Let us go back to the rudimentary text book where output is the sum of C(onsumption), I(nvestment), G(overnment), E(xports) and I(mports). This holds for any sector. The table shows that consumption growth does not have a strong relationship with industrial growth — which means that we need more of the other factors to help in growth. Government expenditure also does not impact industry in the same year — this means that all the fiscal stimulus packages would really take time to work out as the impact is indirect. Trade however is significant.
Therefore, the primary factors are really investment and foreign trade growth. Further, the growth in capital issues, foreign investment and the Sensex are not associated with industrial growth. This means that the rate of change in these variables is not correlated with the industrial growth rate.
Given this picture, how can we relate the present circumstances with the industrial scenario? On the supply side, we have witnessed growth in bank credit rising and imports, which means that industrial growth has taken place up to October. Sentiments are low as gauged by FII, FDI and capital market indicators. There is a shoulder shrug as far as investment is concerned as we do not have clear indications — bank credit partly reflects growth but lower capital issues could negate this performance. The government stimulus package does not appear to have the strength to change things, nor would private consumption. As exports growth is not too impressive, the demand stimulus would not be there. The imports route will work provided the demand is there, as imports only talk of the supply side. The low growth of the energy sector shows that there are roadblocks ahead.
All this points towards difficulties in the times to come and conjectures of this sector’s growth should logically be conservative in general.