Economy’s potential growth falling is serious
Purists will point out that had FY13 GDP data not been revised, FY14 growth would have been an even lower 4.4% instead of 4.9% as per the CSO’s Advance Estimates out last week. And the finance minister takes pride in the fact that growth in the second half of the year is likely to be around 5.2% from 4.6% in the first half. The real issue, however, is what it will take to get growth back to even 6-7% levels, the 9-10% levels of some years ago seem a distant memory. The Project Management Group and the Cabinet Committee on Investments, as most analysts point out, are a critical part of this journey. Years of slowing investment—gross fixed capital formation which was growing at 16% annually during the 9-10% GDP growth days of FY06-FY08 collapsed to a mere 0.2% in FY14 according to the advance estimates. Two things have happened as a consequence of this. One, based on the ICOR of 4 in the late 2000s, the fall in gross capital formation has resulted in a fall in GDP growth of around 0.6-0.7 percentage points. Two, as a result of slowing investments that eventually result in higher productivity gains, India’s potential output has slowed dramatically. This ‘output gap’ is what keeps inflation low—if the output gap has come down, as looks the case right now, this largely explains why inflation is so high in the face of such low growth and suggests inflation will remain on edge for some time to come and will keep interest rates high. That, in turn, will have its own implications for economic growth and investments.
Many expect investment to increase now that the PMG and CCI are clearing projects quickly and it helps that the new environment minister Veerappa Moily is clearing projects stuck for years; indeed, RBI Governor Raghuram Rajan factors this in his higher future growth projections. The problem, however, is that most of these projects were conceived in the go-go days of 9-10% GDP growth; at current growth rates, the projects are largely unviable. If the projects are to take off, what is required is that many simply be rebid instead of wasting time on renegotiation as is being done for highway projects. In other cases, after moving quickly in sectors like petroleum, government policy is again getting stuck, even moving backwards, as in the case of the LPG caps. And since increased savings is critical for growth to come back, the government simply has to control its spending—it was increased government savings that very largely led to the mid-2000s boom and it is increased dis-savings that is behind the current slowing. Getting private companies to investing again will take time, but it is critical to move in areas where, as yet, they are still interested—coal, petroleum and defence are obvious areas that come to mind. Progress in opening up coal, petroleum and defence is slow and, as the edit below argues, even in the case of the more successful telecom area, government policy continues to be unfriendly.