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Reviving Industrial Growth

Need to Address Demand Constraint

M Suresh Babu (sureshbabum@iitm.ac.in) is professor and P Jithin (jithinpchand21@gmail.com) is doctoral fellow, Department of Humanities and Social Sciences, Indian Institute of Technology Madras, Chennai.

The Indian economy faces an uphill task of reviving industrial growth in the post-pandemic scenario. The early onset of domestic slowdown and global disruptions have affected the industrial sector, both in terms of demand and supply factors. What is required at this juncture is not a set of scattered short-term policies, but a coherent heavy lifting of the sector through demand injection and stimulation, because the slowdown started much earlier and is structural in nature.

As the economy is going through an unprecedented crises due to the pandemic and the subsequent lockdown, strategies to revive growth in a phased manner are attracting attention. While the current debate on the projected rate of growth for the fiscal year 2020–21 has some merits, these can only be viewed, at best, as a set of scenarios. The more important issue, however, irrespective of the precise rate of growth of gross domestic product (GDP), is to outline an approach to put the economy back on track. It is here that a deeper understanding of the current crisis is necessary as the economy had started to slow down much earlier. The consequen­ces of the present crisis are reflected, at best, at the sectoral level, as aggregation masks the enormity of the problem. Hence, a departure from the conventional analysis of the supply-side factors that hinder growth could enhance the possibility of formulating more realistic policies towards growth revival. A structural analysis could provide useful insi­ghts as it emphasises on the sectoral features of the economy, that need to be taken into account in designing policy responses. This can be done by assigning an important role for the state in faci­litating changes in the existing structure at the sectoral level.

An economy’s structure of factor endo­wments, defined as the relative composition of natural resources, labour, human and physical capital, is given at each stage of development and differs from one stage to another. Hence, the optimal industrial structure of the eco­nomy will differ at different stages of ­development. Different industrial structures imply, in addition to differences in capital intensity of industries, differences in optimal firm size, scale of production, and complexities in transactions. However, each industrial structure requires corresponding soft and hard ­infrastructures to facilitate production and exch­ange. Post-COVID-19, the structure of factor endowments would change, driven by changes in physical capital as private investment growth, which is already sluggish, is likely to slow down even further. This warrants a revitalising of the industrial structure in light of the current ­developments. This is accentuated by the trends in industrial growth, which suggest that the fluctuations and decline in growth had started much earlier. Thus, in a sense, the post-crisis industrial growth trajectory had already started to take shape earlier. This makes the task of reviving growth even more daunting as the policy responses have to factor in the structural issues along with the ­cyclical problems.

The slowdown started much earlier: In Figure 1 (p 17), the growth rate of the index of industrial production (IIP) with base year 2011–12, since 2012, is presented. The component wise break-up shows that the growth rate of electricity is inc­reasing in the initial period up to 14.8% in 2014–15 and decreases sharply to 5.7% in 2015–16. After this fluctuation, it is more or less stable across the years. The growth rate of mining also increased over the period, while the growth rate of manufacturing did change substantially over the years, hovering between 3.5% and 5%. Any change in the growth of manufacturing industries will have a significant impact on the aggregate indu­strial growth as it has 77.63% weight in the overall IIP.

Focusing on the manufacturing sector, in Table 1 (p 17), we map out the pattern of growth at the industry level from April 2012 to August 2019, that is, for a period of 89 months. This detailed analysis is intended to provide a temporal perspective. It should be noted that we do not adjust the IIP in terms of seasonal effects. We classify industries in terms of their monthly growth rates of IIP into four intervals; (i) less than 2%, (ii) 2% to 5%, (iii) 5% to 8%, and (iv) more than 8% to identify the growth dampeners and growth drivers. It is evident from the table that there exist significant ­variations in growth rates across industries. We draw the following inferences:

(i) Industries such as manufacture of paper and paper products, printing and rep­roduction of recorded media, manufacture of rubber and plastics products, manufacture of fabricated metal products, except machinery and equipment, manufacture of motor vehicles, trailers and semi-trailers, and other manufacturing can be classified as less growth-inducing industries, as the growth rate of these industries was less than 2% in more than 50 out of 89 months considered. Out of these, the manufacture of paper and paper products is a major growth-dampening industry registering less than 2% growth in 55 out of 89 months.

(ii) Industries such as the manufacture of pharmaceuticals, medicinal chemical and botanical products, manufacture of basic metals, manufacture of computer, electronic and optical products are growth-inducing industries since the growth rate of industries fall below 2% in only for less than 30 months during the period considered. Among these, manufacture of basic metals is a leading industry registering higher growth rates for most of the months.

(iii) Industries with growth rates excee­ding 8% are considerably less. Industries such as the manufacture of pharmaceuticals, medicinal chemical and botanical products, manufacture of computer, electronic and optical products have growth rates higher than 8% in more than 38 months out of 89 months.

Industries such as manufacture of beve­rages, manufacture of wood and products of wood and cork, except furniture, manufacture of articles of straw and plaiting materials, manufacture of paper and paper products, manufacture of coke and refined petroleum products, printing and reproduction of recorded media, manufacture of chemicals and chemical products, manufacture of machinery and equipment, and manufacture of motor vehicles, trailers and semi-trailers have recorded more than 8% growth in less than 20 out of 89 months.

The overall growth rate of Indian manufacturing industries is skewed towards the low growth region as all industries, except the manufacture of pharmaceuticals, medicinal chemical and botanical products, and manufacture of furniture, have less than 5% growth rate in more than 40 out of 89 months.

The analysis of growth rates has not taken into account the individual industry’s weight in IIP to decipher the overall impact on industrial growth. Considering the weights of industries in the IIP, the manufacture of coke and refined pet­roleum products has a weight of 11.775%, and it has registered more than 8% growth in only 16 months. The major contributors to the IIP all have registered modest growth rates since they have less than 5% growth in 47 months and more than 5% growth for only 42 of 89 months considered. To summarise, we identified the growth drivers and dampeners within the manufacturing sector, based on growth rates of industries and their contribution to the IIP. The growth-dampening industries are manufacturers of textiles, chemicals and chemical products, rubber and plastics products and mac­hinery and equipment. The growth drivers identified are manufactures of wearing apparel, pharmaceuticals, medicinal chemical and botanical products, basic metals, computer, electronic and optical products as it has less than 2% growth rate in fewer months and more than 5% in more months than other industries.

We take up the growth dampeners and drivers for further scrutiny. Figure 2 (p 17) portrays the annual growth rates of growth dampening industries for 2012–13 to 2018–19. It reveals that the growth rates decline continuously after 2013. Growth of manufacture of rubber and plastic products declined drastically from 11.3% in 2013–14 to -8.2% in 2017–18. These dampening industries registered a further decrease in growth in 2017–18 as the growth rates of industries such as manufacture of chemical and chemical products decreased from 2.5% in 2016–17 to -0.3% in 2017–18, manufacture of rubber and plastic products declined from 1.9% to -8.2%, and the manufacture of machinery and equipment decreased from 7.7% to 5.6%. The policy shock due to demonetisation could be one of the reasons for the decline in the growth rates in 2017–18. This is corroborated by the fact that the Economic Survey, 2016–17 acknowledges that demonetisation could have resulted in a quarter to 1 percentage point loss of GDP. Interestingly, the dampening industries revived as it ­recorded favourable growth rates after 2017–18.

Figure 3 presents the annual growth rates of growth drivers for the period 2012–13 to 2018–19. It is evident that the industry group—manufacture of pharm­aceuticals, medicinal chemical and bota­nical products—is the leading growth driver till 2017–18 as this group registered a tremendous increase in the growth rates from 8.1% in 2012–13 to 23.1% in 2017–18. Surprisingly, we find a declining trend in the growth rates of all growth-inducing industries, except the manufacture of wearing apparel in 2018–19, which points to an overall slowdown in the manufacturing sector.

Viewed from a different perspective, in Table 2, we present the monthly growth rates in terms of use-based classification of industries for 89 months. We find that primary goods, capital goods, and intermediate goods are not growth-inducing as it has less than 5% growth in more than 60 out of the 89 months considered. The growth rates of primary goods and that of intermediate goods are less than 5% in 61 months, which together contribute 51.27% weight in the IIP. These three industries are thus less growth-inducing. The growth rate of infrastructure/construction goods, consumer durables, consumer non-durables are less than 5% in 54 months out of the 89 months. Concurrently, the growth rates of consumer durables and consumer non-durables are more than 5% in 36 months and 44 months, respectively. The growth rate of infrastructure is more than 5% in 40 months out of 89 months. It indicates that industries such as infrastructure/construction goods, consumer durables, and consumer non-durables have been the main growth drivers during this period.

The issue of demand constraints: Analyses of the earlier episodes of industrial growth slowdown identify the factors constraining growth mainly in terms of “supply constraints” and shortages in savings as the binding constraints. Supply constraints were attributed to the ­inadequacy in the production of capital goods. For the subsequent episodes, “inf­rastructural bottlenecks” had been iden­tified as an important factor limiting ind­ustrial growth. However, in bulk of these earlier discussions, the question as to “whether there is not some role for ‘demand’ as a factor constraining growth, even in a low income economy such as India” has remained as an unsettled issue, often overlooked by the policy practitioners as well (Chakravarty 1983). The question of demand has surfaced again as it connects to the current debates on growth slowdown, and especially whether the present tepid growth is because of supply inflexibilities or the lack of aggregate demand.

The Reserve Bank of India’s results of the 48th round of the Order Books, Inventories and Capacity Utilisation Survey (OBICUS) for the quarter October–December 2019 covering 704 manufacturing companies provides a snapshot of demand conditions in the manufacturing sector. According to the survey, capa­city utilisation at the aggregate level declined to 68.6% in Q3: 2019–20 from 69.1% in the previous quarter. It should be noted that capacity utilisation in Q4 2018–19 was 76.1%, and since then, there has been a steady decline in the successive quarters. This decline in capacity utilisation is reflected in the growth of new orders for firms during the corresponding period. This measure of capacity utilisation broadly tracks the de-trended IIP. The continuous decline and the current low levels of cap­acity utilisation are clearly a reflection of low levels of demand in the economy.

A low level of aggregate demand is the end result of a combination of factors. First, it happens as a result of the decline in GDP growth. In January 2020, before the budget, data released by the Ministry of Statistics and Programme Implementation (MOSPI) predicted that India’s GDP will grow by just 5% in the current financial year (2019–20), the lowest since the 2008 economic crisis. For the financial year 2018–19, the economy grew at 6.8%. India’s GDP growth in the July–September quarter of 2019 slowed sharply to 4.5%, the weakest pace in more than six years. Citing a sharp economic slowdown in India and other emerging markets, the International Monetary Fund (IMF) lowered the growth estimate for the world economy to 2.9% for 2019. Besides, the IMF also trimmed India’s growth estimate to 4.8% for 2019, citing stress in the non-banking financial sector and weak rural income growth.

Second, rural wages, which are critical for the overall demand in the eco­nomy, barely rose during 2018–19. This has fuelled a slowdown in both consumption and corporate earnings. Real agricultural wages have not grown substantially for several months. For example, real wages grew 2% back in February 2019, compared to a 1.5% rise in January 2019. Similarly, growth in real non-farm wages has been weak as they grew 1.4% in February 2019, compared to 2% in the previous month. According to data from the Labour Bureau, neither of these measures of wages has risen above 4% in the nine months of 2019. In fact, the decline in rural wages started earlier; rural wages actually declined during several months. For instance, real growth in agricultural wages remained in the negative territory for each of the four months between April and July 2018. Thus, the two measures combined, that is, agricultural wages and non-farm wages, convey a picture of depressed rural earnings, which has affected the aggregate demand.

Third, the weakening external sector has put additional pressure on the demand for manufacturing sector’s output. Merchandise exports fell by 1.1% back in ­October 2019 itself, contracting for the third consecutive month, while imp­orts fell for the fifth month in a row by 16.3%, leading to a trade deficit of $11 billion. Out of the 30 major items each in India’s export and import baskets, 18 export items and 22 imported goods witne­ssed contraction in the third quarter of 2019–20. Ready-made garment exports, for instance, fell by -2.1%, and petroleum products by -14.6%. Among major importing items, coal fell -28.7%, petroleum -31.7%, chemicals -24.4%, plastic material -10.5%, precious stones -17.6%, iron and steel -14.3%, and electronic goods shrank by -8.5%. During the first seven months of the fiscal 2019–20 (April–October), exports have contracted 2.2%, while imports shrank 8.4%. Thus, we find that manufacturing sector is constrained by both domestic as well as external demand.

Concluding Observations

Stimulating industrial growth in India in the post-COVID-19 crisis era presents an enormous challenge for policymakers. A comprehensive analysis of the factors that drive industrial growth is needed to address this. Early responses during the crisis have considered only a part of the problem, that is, the supply-side issues. This has led to the usual set of policies, such as easing the access to credit and improving the investment climate. The latter has attracted attention as there is an optimism that, in the post-crisis period, firms might leave China in search of new destinations. To attract these firms, states are creating land banks and competing to ease labour laws. Such policies are intended to attract foreign direct investments and the associated “spillover” effects. Ironically, the expectation of increased flows in foreign investments is at a time when domestic private investments are not growing. Currently, after going through successive quarters of slowdown in industrial growth, and with the prospects of it continuing for more time, we are back to the old question, that is: Is the slowdown ­cyclical or structural? If we are to reckon with the cyclical nature of slowdown, just as a series of bad quarters, then the sector will correct the imbalances with an adequate dose of monetary and credit stimulus. However, if it is more serious in terms of structural problems, then the policy interventions will have to go ­beyond the current practice of monetary interferences, especially that of tinke­ring with the repo rates.

Viewed from a broader perspective, despite the large doses of reforms to transform into a market economy, the Indian economy still exhibits symptoms of continuous disequilibrium in markets. Interestingly, these imbalances are similar to the demand deficiency problem, that are more typical of free-market economies and the issue of supply bottlenecks are more often manifested in the centrally-planned economies. The coexistence of both of these problems constrain the role of price mechanism in the economy, leading to the questioning of the standard assumptions implicit in price behaviour that all markets are continuously in equilibrium prices and res­pond quickly to clear any imbalance ­between demand and supply. Hence, there exists a need to explore alternate frameworks, departing from neoclassical macro models to explain the working of markets, that is, there exists a need to take into account the fact that markets are not cleared by movements in price. Explorations in this direction yields imp­ortant insights on the role of structural factors that hamper growth (Babu 2018). Our argument underscores the need for such an analysis, as the current sluggish industrial growth is not cyclical, but more structural in nature. The manifestations of a downward growth spiral started to surface early and has now res­ulted in an overall growth slowdown, which, if not addressed in a more realistic way, would last for a longer spell.

References

Chakravarty, Sukhamoy (1983): “Some Reflections on Indian Development Strategy” (Inaugural address to the Eighth Indian Social Science Congress held at Hyderabad on 9 July 1983), Eastern Economist, Vol 1, No 2, July–September, pp 29–32.

Babu, Suresh (2018): Hastening Slowly: India’s Indu­strial Growth in the Era of Economic Reforms, Orient Blackswan India.

Government of India, Ministry of Statistics and Programme Implementation, Index of Industrial Production data.

 

Updated On : 29th Jul, 2020

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