Column : Productivity, investment & reforms

Slow growth, sticky inflation and hopes of economic reforms driving a recovery—these are the issues that nowadays dominate any discussion about the Indian economy. While low growth and high inflation are symptoms of economic challenges, a sustained cure cannot be found without diagnosing the root causes. To put it differently, the effectiveness of the suggested remedies would also depend crucially on whether the problems are correctly diagnosed or not.

India's GDP growth plunged sharply to 5.5% in Q1-FY13 (year ending March 2013), from 9.2% in Q4-FY11. As near-term growth deteriorates, a question often asked is whether potential long-term economic growth has also been affected. Can India ever achieve 8%-plus growth rates again? Estimating potential growth is a hazardous task for rapidly transforming economies like India because of a paucity of quality data and the rapidly changing relationships between different economic variables. However, a careful examination of data trends suggests that declining productivity and falling investment rate have been the main culprits, dragging down India's potential growth from FY08 onwards.

Slowing down of the capex cycle is a common explanation of the growth challenges. The average investment rate (ratio of gross domestic capital formation, 'GDCF', to GDP) fell to around 34% in FY12 from 38% in FY08 and is likely to fall further. The trend is more worrying for gross fixed capital formation (GFCF) where the GFCF-to-GDP ratio fell to around 29% from 33% over the same period. The gross domestic savings also fell at a fast clip, widening the savings-investment gap and leading to a current account deficit of 4.2% of GDP in FY12. Not only is investment falling, our ability to finance investment from domestic resources has also been strained.

Falling public sector savings or rising fiscal deficit has surely been a reason behind the declining investment rate. But we worry more about the private corporate capital expenditure. According to RBI data on corporate investment, the aggregate investment intentions in private-sector projects (only projects larger than R100 million were considered) funded by banks and other financial institutions declined 46% between FY11 and FY12. Capital expenditure on new projects approved in FY12 totalled only R746 billion, a drop of 32% from the previous year. Indian corporates also seem to have been inspired by the mantra of 'small is beautiful'—the share of large projects (R50 billion and above) dropped to 33% in FY12 from 48% in FY11.

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