From slowdown to slump?

The instability created by the September 11 terror could adversely affect India's services sector and precipitate the ongoing slowdown into a crisis.

ACROSS the world, attention is focussed on the economic aftermath of the incidents of September 11. As a result what gets missed or underplayed is the state and direction of movement of individual economies prior to that date. In India's case, evidence of its economic performance till July 2001, which has recently become available, points to a sharp deceleration in growth over the first four months (April-July) of this financial year, which was well before September.

According to the quick estimates of quarterly Gross Domestic Product (GDP) growth released by the Central Statistical Organisation (CSO), the Indian economy had settled at a 6 per cent growth rate during the four quarters beginning July-September 2000. However, over the subsequent two quarters, growth slipped to 5 and 3.8 per cent respectively, and stood at 4.4 per cent during the first quarter (April-June) of 2001-02. This shift to a lower growth rate of between 4 and 5 per cent over three quarters is a clear sign of deceleration.

What is noteworthy is that this slide in the pace of growth has essentially been the result of a deceleration in the growth of the commodity-producing sectors: agriculture and manufacturing. Ever since the third quarter of 1999-2000, the agricultural sector appears to be performing extremely poorly, with growth rates of agricultural GDP being negative in three of the subsequent six quarters and less than one per cent in two.

On the other hand, in manufacturing, starting from a GDP growth that touched the 7 per cent plus level in the second half of 1999-2000, growth fell to 6 per cent during the second and third quarters of 2000-01 and then slumped to 3.5 and 2.3 per cent during the next two quarters. Going by the Index of Industrial Production, the slowdown in manufacturing has been sharper, with the growth rate relative to the corresponding period in the previous year falling from 6.2 per cent during April-July 2000 to 2.6 per cent during April-July 2001.

What this suggests is that starved of adequate investments for more than a decade now, agricultural growth has reached saturation levels, despite signs of some diversification in terms of crops grown. Behind the investment slowdown is the stagnation and even decline in real public investment in the rural sector in general and agriculture in particular. Given the observed complementarity between public and private investment in agriculture, with the former known to drive the latter, the spur to private investment provided by high and rising support prices for a number of crops has been inadequate to neutralise the basic tendency towards sluggish capital formation. In the event, despite the fact that at a generalised, all-India level, monsoons have been normal or munificent in India for some time now, agricultural growth has remained sluggish.

THE story in the manufacturing sector is, however, substantially different. Manufacturing growth has declined largely because of sluggish demand conditions. There are two ways in which demand for domestically produced manufactured goods can falter. First, the overall growth in the domestic market could slow down, reducing the demand for manufactures. Second, the share of domestic producers in a market of a given size can decline, because of competition from international producers.

Once the post-liberalisation surge in demand for import-intensive manufactures had been satiated, the first of these factors did play a role in putting the brakes on industrial growth. Not only has the second half of the 1990s been characterised by some measure of success in the government's effort to reduce the fiscal deficit in the Central budget, but this has occurred at a time when the tax-GDP ratio has fallen by close to two percentage points. The squeeze in expenditures that this reflects would have substantially dampened the fiscal stimulus that was the prime driving force behind industrial demand and growth during the 1980s. With the effects of the sluggishness in the growth of agricultural incomes adding to this, it is only to be expected that the growth of the home market would have been constrained. That is, industrial growth is constrained from the demand side.

Was the impact of this on domestic producers of manufactures aggravated by competition from abroad in the aftermath of liberalisation? Till recently the evidence of displacement of domestic production by imports was anecdotal at best. At the aggregate level, barring the high growth years of 1994-95, 1995-96 and 1996-97, when India's import bill rose faster than its GDP, the decade of the 1990s was characterised by relatively small increases and even declines in the value of non-oil imports in general and non-oil, manufactured imports in particular. Thus, non-oil import values rose by just 3.2 per cent over 1999-2000 and fell by 8.5 per cent during 2000-01. The sluggishness in non-oil import values has been consistently used by the government to dismiss fears of an import surge in the wake of liberalisation. But a closer look indicates that aggregate, non-oil import values grew slowly not because of slow growth in the quantum of imports, but because the effects of an increase in quantities imported on the size of India's import bill was neutralised by a fall in the unit values or prices of imports. In fact, the statistical evidence for the fact that India has become a destination for cheaper imports after liberalisation only corroborates the often alarmist, "grassroots" view that the Indian market is flooded with cheap imports of a range of commodities from countries like China.

What is more disconcerting is the evidence that the current deceleration in growth has been accompanied by an increase in the non-oil import bill. Provisional trade statistics indicate that during the second quarter of this financial year (June-August), non-oil imports rose by 16 per cent when compared with the corresponding period of the previous year, resulting in a 6.8 per cent rise in India's overall import bill despite a 11 per cent fall in oil imports. Part of this rise may have been owing to an increase in the imports of gold, since the poor performance of financial markets has rendered investments in gold attractive. Although commodity-wise import figures for the second quarter are not yet available, it is reported that the first quarter of this year (April-June) saw a 33.5 per cent increase in the value of gold imports from $1.2 billion to $1.6 billion. With gold imports accounting for about 20 per cent of all non-oil imports, such increases are bound to affect the overall import bill quite substantially. But to the extent that this factor alone does not explain the recent increases in non-oil imports, and given the evidence of a decline in the unit values of many non-oil product imports, the role of import competition in explaining the deceleration in manufacturing growth could be significant.

With agricultural and industrial growth dampened by these factors, aggregate GDP growth has managed to touch at least the levels they have in recent quarters only because of the buoyancy of the services sectors. GDP growth rates in the financing, insurance, real estate and business services sector have been well above 9 per cent in most recent quarters, and that in community, social and personal services fluctuated between 6.2 and 9.3 per cent. Even in the Trade, Hotels, Transport and Communications sector, which too has witnessed a deceleration in GDP growth, the rate of growth has remained above 5 per cent. It is this resilience in the services sectors that has allowed aggregate GDP growth to remain in the 4-5 per cent range.

THESE trends in the pace and pattern of growth in the Indian economy have two implications. First, since inadequate public investment and faltering demand explain the deceleration of growth in the commodity producing sectors, "supply side" policies cannot trigger a recovery. Hence, arguments that advocate more and faster reform as the means to trigger a recovery are completely misplaced. In fact, liberalisation of imports and the fiscal squeeze associated with reform have been in large part responsible for the slowdown in growth. What is required for a reversal of the process is a more aggressive use of tariffs, anti-dumping duties and the like in order to deal with unequal competition from abroad. This needs to be combined with stepped up public investment and expenditure, and an innovative use of the large food stocks available with the government, both to increase capital formation and stimulate demand. In recent times, the government has espoused such views, but an ideological obsession with import liberalisation and deficit reduction have prevented the translation of those views into practice.

The second implication of our analysis of the pace and pattern of growth is that, given the crucial role of the services sectors in propping up aggregate growth, any development that adversely affects the fragile service economy can accelerate the slide in growth. The events of September 11 and their aftermath have rendered this threat more real. Given the impact that these developments are having on the airline industry, the insurance business and the business services and financial sectors, a sharp slowdown of growth in the services sectors is more than likely. As a result, the artificial prop provided to India's economic performance by these sectors can give way, converting the slowdown into a slump. Efforts to revive the commodity producing sectors are therefore crucial if India is to deal with the instability that the September 11 terror attacks have unleashed. But with the Indian government paralysed by its own liberalisation agenda, there are no signs of such a response as yet.