Challenges before India’s growth story: Financial Express 23rd August 2018

Manufacturing’s contribution to GDP needs to get improve, and capital formation in the economy and the savings situation must get better.

The growth path in the Indian economy has been hazy at best in the last six years or so, with a certain modicum of desperation on our part to prove that things are looking brighter. This is notwithstanding the recent controversy on the back-series on GDP based on the new methodology, a matter that has now acquired political overtones.

GDP growth in FY16 was 8.2% and came down to 7.1% in FY17 (partly due to demonetisation) and further to 6.7% in FY18 (partly due to GST). There is hope that things will get better this year, and estimates are in the range of 7-7.5%. For sure, these growth rates are much lower than the 8-9% growth that we had taken for granted in the past. The hubris of the past notwithstanding, today, aspirations are more modest and a gentle ascent is what is being conjectured. But, there are some pain points when one looks at some of the major edifices in the economy. It can also be said as a corollary that, if these issues are not addressed, the sustainability of growth may come under a cloud as the present structure is not appropriate.

The first pertains to the composition of the GVA from FY12 onwards. It springs some surprises. There was a decline in the shares of two sectors—industry and construction—and that is quite significant. The share of industry, which includes mining, manufacturing and electricity, came down continuously from 32.5% to 29.1% in FY18. This would not normally be expected as the largest quantities of investment get directed to minerals, power and manufacturing. Clearly, the controversies in awarding of contracts in infrastructure in the pre-2015 period, followed by the funding challenges for the banking system with the increase in NPAs, has contributed to the decline in investment. Further, excess capacity has come in the way of the growth of these sectors.

The share of construction in GVA has come down from 9.6% to 7.4%. This is significant because there have been several reports on the relentless thrust of the government on roads and housing that should have, ideally, got captured here. Evidently, the amounts involved are quite small relative to the size of the economy, which has resulted in a declining share.

The second pertains to capital formation, which is a reflection of gross investment taking place in the economy. This has come down continuously over the years from 39% in FY12 to 30.6% in FY18 and has to be reversed to build the base for future growth.

The decline in capital formation started in a big way from FY14 onwards, when there were several controversies regarding irregularities in various sectors like telecom, power, coal, iron ore, etc. This, in turn, led to an increase in stalled projects, estimated at `4-6 lakh crore over a period of time. Despite streamlining of processes for resource allocation and clearing of projects, the quantum of abandoned projects had increased and there was further a slowdown in new projects. This was also the period when the NPA story really started, leading to further deceleration in fresh capital formation that, in turn, has resulted in such low numbers.
The third area of concern is savings. Savings are important as they finance capital formation, and the trends over the six years ending FY17 suggest that a lot of comfort that we have received on the external account, of low current account deficit, is mainly due to investment rate declining in consonance with the savings rate. Theoretically, the savings-investment gap is the current account deficit as the investment that cannot be financed by domestic savings has to be supported form outside. But, it has been a case of investment equilibrating with savings that had presented a better picture on the external front. This should ideally not be the case as it means that decline in investment has led to lower demand for funds.

The accompanying graphic shows that the overall savings rate had declined continuously from FY13 till FY17. The household sector, which was the largest contributor to total savings with almost a two-thirds share, accounts for just under 55% in FY17. The share of the private corporate sector has increased during this time period. Quite clearly, household savings have been impacted by a lower ability at thrift in terms of both financial avenues and physical assets. One reason can be because of more money being spent on consumption. While we tend to look at current inflation and take solace in these numbers coming down, consumption gets affected by cumulative inflation, especially in food, which comes in the way of savings. People are spending more on necessities and not on durable goods which gets reflected in the decline in share of physical savings by over 6% of GDP.

Therefore, the overall profile of growth in the last seven years does instil a feeling of discomfort as it is being driven more by the service sector; though this may be good in the short run, it can’t be sustained in the long run unless physical production increases in importance. Services need to support agriculture and manufacturing, and what is seen in our case is that the higher share of services (which increased by 4% in this period) has been driven by the government sector in three out of the six years and by the financial, real estate and professional services segment in the other three. This is not a sustainable model given that the financial sector is in a stage of transformation and has to grow in conformity with the manufacturing sector to eschew issues like adverse selection which has resulted in the NPA issue today.

The call to ensure that the share of manufacturing goes up in GDP supported by strong investment has always been there. This has not happened, and low demand conditions and an unstable banking system are major concerns. Employment has to increase to push up consumption which will gradually feed into new investment as optimal capacity utilisation rates are achieved. Investment in infrastructure has to re-commence from the side of the private sector as the thrust provided by the central government is not enough and states have limited fiscal space for the same. Funding is a challenge and practically speaking the next two years will be transformative and we have to get the plot right to get growth back on trajectory.