Not so industrious

Revival of industrial growth requires supply-side liberation

The Index of Industrial Production numbers for February 2011 released by the Central Statistical Organisation provide little cheer from the pervasive grey enveloping the sector over the past few months. Industrial production for the month was 3.6 per cent higher (year-on-year) than the corresponding figure last year. The results are even more sobering when seasonally adjusted production figures are considered: production in February was down 0.6 per cent as opposed to a marginal increase of 1.3 per cent in January. A review of the performance of each industry within the sector is instructive. Capital goods production declined for the third consecutive term registering a decline of 18.4 per cent, though a high base effect (the sector grew 47 per cent during March-July 2010) adversely affected performance. Consumer goods production, on the other hand, grew by 11.4 per cent (year-on-year), driven by a sharp increase in the production of consumer durables. Mining production in February actually slowed to 0.6 per cent (as opposed to 11 per cent in February 2010) largely as a result of environmental restrictions on the production of coal.

While a high base effect has contributed to the less-than flattering performance of the sector, it would be dangerous to ignore structural factors that could have led to the industrial slowdown. For example, Gross Capital Formation (measured by investments and equipment, construction, raw materials and inventories) for the top 25 private-sector groups in India declined by 50 per cent from Rs 1.69 trillion to Rs 0.81 trillion between 2008-09 and 2009-10. While this coincided with the darkest days of the global economic slowdown, one would expect that investments by these groups would continue. Steadily increasing interest rates have definitely increased the cost of capital for most players in the private sector, except those with a corpus of retained earnings to fund their capex plans. Global liquidity is still tight, a far cry from the glory days of 2003-2008. With oil prices between $120 and $130, and threatening to surge even higher combined with high commodity prices, it would be overly optimistic to expect inflation to decline sharply any time soon. The RBI may have little choice but to raise interest rates even further, which would leave under-leveraged firms largely untouched, but would adversely impact consumption and investment.

Dampened expectations of the future due to the glacial pace of economic and administrative reform, coupled with frustrating policy uncertainty, could well be another (more serious) reason for the slowdown in private investment. The government has never been short of voice in making bold pronouncements about its commitment to reform or predicting a rapid turnaround of the economy in the second half of FY11, but the reality is very different. India remains one of the most difficult places in the world to do business in. Supply-side constraints continue to dog industrial performance. Policy, at the Centre and states, must focus on liberating Indian business from these constraints.