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The domestic investment story,which saved India post recession,is unravelling

Written by MK VENU |
June 5, 2012 1:54:01 am

The domestic investment story,which saved India post recession,is unravelling

Last week,the term “growth shock” was used to describe the unexpectedly low GDP growth of 5.3 per cent for the last quarter (January-March) of 2012. The consensus estimate by most analysts was that the last quarter would deliver more than 6 per cent growth,at the very least. As it turned out,the GDP growth came closer to 5 per cent,a number many economists regard as the upgraded Hindu rate of growth. Just to refresh memory,the original Hindu rate of growth,as described by the economist Raj Krishna,was about 3-3.5 per cent,which prevailed between 1950 and 1980. So getting close to the neo Hindu rate of growth (5 per cent),even if for a quarter,has some shock value. It is also a grim reminder that the “rising India” story cannot be taken for granted against the backdrop of global economic weakness.

Of course,the saving grace is we still managed to get a GDP growth of 6.5 per cent for the entire fiscal of 2011-12,even if the last quarter was the worst we had seen in many years. It was also interesting that Finance Minister Pranab Mukherjee chose to mention two specific reasons that might have contributed to the dramatic fall in the GDP growth of the last quarter. One,the RBI had kept interest rates too high for too long. Industry,especially small businesses,has been crying itself hoarse over the high cost of capital for some time. Fresh private investment virtually came to a halt as the cost of capital began to make the critical difference in the decision on making new investments.

The second reason cited by Mukherjee for the rapidly slowing growth is the lack of mining clearances. This is borne out by fresh data suggesting a 0.9 per cent negative growth in mining output in 2011-12. The only other time when mining output showed negative growth was in 1971,when it contracted by 6.9 per cent. How can you get reasonably high growth when mining output is declining? For coal,iron ore,aluminium,bauxite and copper are key industrial inputs.

To be sure,this problem has occupied the mindspace of policymakers at the highest level for sometime now. Prime Minister Manmohan Singh suggested a year ago that if coal mining output grew at a meagre 1.5 per cent then you could not get a GDP growth of 8 per cent plus. Unfortunately,he diagnosed the problem right but did not provide a lasting cure. Even now,several coal-mining clearances remain stalled as the new principal secretary to the prime minister Pulok Chatterji tries hard to get the environment ministry to clear them. Given the vitiated political climate,even Chatterji’s efforts are coming somewhat unstuck.

Lack of decision-making in the bureaucracy,which began in the wake of various CAG-induced controversies,is something that is getting worse by the day. Now we have a CBI inquiry on coal allocations made directly under the PMO’s administration. This,indeed,must be seen as the last straw on the camel’s back. If even the prime minister is perceived to be under scrutiny,the decision-making process is sure to move from the second gear to the first,before stalling completely.

To be fair,the decline in mining output,for the first time since 1971,is also partly due to the large-scale closure of illegal mines in Karnataka and Goa. Goa Chief Minister Manohar Parrikar recently told The Indian Express that he was,in fact,planning to further reduce mining output in order to reverse environmental damage. In Karnataka too,no alternative mechanism has been put in place to legally revive mining output. These factors,until they get resolved through a judicial/ democratic process,will have a negative impact on national output.

These domestic governance issues have combined with fresh uncertainties in the eurozone to create a double whammy for the economy. The overall negative sentiment caused by both domestic and global factors is making businesses postpone their investments. This is becoming a sort of self-fulfilling prophecy. For instance,in normal times,businesses start planning fresh investments once they hit 90 per cent of their existing production capacity. Based on normal demand projections,they like to have fresh production facility in place before their existing capacity reaches 100 per cent. This is also rational behaviour. They do this based on normal,expected demand growth trends.

But in times such as these,businesses tend to wait even after hitting 100 per cent production capacity because they are not sure about the overall economic climate and future demand growth. Consequently,they hold back fresh investments. So the lack of adequate new investment actually ends up further slowing demand growth. This is how the self-fulfilling prophecy works. And India’s GDP growth is roughly 50 per cent consumption-driven and 50 per cent investment-driven. It is now feared that the investment-led GDP growth is seriously at risk.

It was precisely this domestic investment story that saved India after the worst global recession in six decades shook every economy in 2008-09. India had a GDP growth of 6.8 per cent in 2008-09 after absorbing humongous financial and economic shocks. So the question then to ask is why has the Indian economy done worse in 2011-12,with just 6.5 per cent GDP growth,than in 2008-09,when the roof seemed to be caving in on us? The answer to this question is simple. The domestic economy held up and showed resilience in 2008-09. A recent RBI study says while real-estate prices collapsed in the Western world and even declined in Indian metros,the prices in Patna stayed not only stable but increased in the year after the 2008 global meltdown. No wonder during 2007-09,Bihar showed an average GDP growth rate of close to 10 per cent. Other relatively laggard states such as Orissa,Chhattisgarh,Assam,Madhya Pradesh and Uttarakhand grew at nearly 7 per cent in the same period. This was the resilience shown by the underdog state economies after the global economic crisis of 2008. Are we now losing that advantage?

While it is true that complex governance issues,loosely described as policy paralysis,have eroded confidence in the domestic economy,one cannot underestimate the role of the massive credit bubble created by most economies after the 2008 meltdown. The credit bubble is gradually unwinding everywhere,including in emerging markets like China,thereby causing the GDPs of most economies to decelerate by up to 2 percentage points. This is causing a lot of pain to over-leveraged businesses whose balance sheets are soaked in debt. This trend is uniform across all emerging markets. Only India has worsened its situation a lot more by its domestic mismanagement of the economy. This is now reflecting in the Indian currency falling much more against the dollar than most emerging market currencies over the past year or so. From here on we can only hope that things improve so that we can leave the neo Hindu rate of growth behind.

The writer is managing editor,The Financial Express

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