Rising ICOR is a serious problem
Though the relationship between investments and GDP growth isn’t as mechanical as the incremental capital output ratio (ICOR) suggests, over the medium term it is worrying if the ICOR is rising as it has been over the past few years. More so if, as is the case now, investment levels are also falling. As the term suggests, the higher the ICOR, the lower the growth impetus in the economy—put another way, a higher ICOR means you need a higher level of investment to get the same GDP growth. At 5.9 for FY13, the ICOR is the highest it has been in the last two decades, but for FY03 when it was 6.1. If India’s investment level is 32% of GDP and the ICOR is 4, a GDP growth of 8% can be expected—if the ICOR rises to 6, however, a long-term growth of just 5.3% can be expected.
As growth picks up, it is true the ICOR will start looking better, but that is only part of the solution; the larger solution lies in making capital investments more productive than they are today. Indeed, with capacity utilisation for industry as low as it is today, it is unlikely investments will pick up until the existing plants are fully used. In other words, any growth kick that India is going to get will have to come from the ICOR improving first.
There are some obvious low-hanging fruit. The bulk of the thermal power capacity in the country, for instance, is operating at a low level as Coal India simply isn’t mining enough coal—imported coal is too expensive to use at the current levels of demand. So, all attempts have to be made to increase private mining—indeed, the next government has to expend whatever political capital is needed to get Parliament to amend the Coal Nationalisation Act to allow private sector merchant miners like BHP Billiton and Rio Tinto to start mining in India. The same low capacity utilisation due to fuel shortages applies to gas-based power plants, which is why the problem regarding the RIL-BP-Niko pricing needs to be resolved at the earliest. A quick decision on extending the lease periods of oil companies like Cairn is also critical if greater exploration is to take place—since the companies have already found the oil, ramping up production is contingent on the government’s lease-extension. In the case of telecom, an early decision on spectrum trading as well as on reducing the spectrum usage charge will give the sector a boost. In the case of agriculture, similarly, moving to per acre subsidies—something the budget talked of last year—instead of per crop MSPs will give a big boost to farming in states like Bihar and West Bengal. Lowering the ICOR has to be to item number one on the next government’s 100-day agenda.