Stuck at the bottom?

Recovery is not guaranteed unless govt spends on asset creation

The GDP numbers for the fourth quarter of 2012-13 indicated that the Indian economy grew by 4.8 per cent, slightly above the 4.7 per cent estimated for the preceding quarter. A realistic interpretation of these numbers would be that the economy has indeed hit bottom and things are unlikely to become worse, at least on the growth front. The critical question is, of course, how soon they will start getting better. Growth for the whole year of 2012-13 came in at five per cent, consistent with the advance estimates released in February; and virtually all forecasts, from public as well as private agencies, indicate that growth will be better during 2013-14. This is a relief because it suggests a widespread perception that growth has bottomed out. Things are unlikely to become any worse. However, the early-year forecasts are based on several assumptions - of the monsoon, oil prices and so on - which may not pan out. Do the quarterly and annual numbers reveal anything about a potential recovery?

From this perspective, the most significant number in the report relates to gross fixed capital formation (GFCF) or, more simply, investment spending. This indicator reflects the magnitude of resources that the economy is allocating to create new capacity. GFCF was 32.6 per cent of GDP in the fourth quarter, slightly lower than the full-year proportion of 33.2 per cent. Over the past eight quarters, this ratio was at its peak, 35.7 per cent, in the first quarter of 2011-12; it was at its trough, 32 per cent, in the third quarter of 2012-13, which also showed the slowest growth rate in this two-year period. While investment spending has been somewhat volatile, the fact that it has moved in a relatively narrow range as a proportion of GDP suggests that a reasonable level of investment is still taking place. A rough rule of thumb using the concept of the incremental capital-output ratio suggests that if the ICOR is four, this level of investment is consistent with about eight per cent growth. This is, presumably, the basis of the government's confidence that growth will revive quite quickly from this bottom. Unfortunately, the investment ratio reflects only the potential. Several things need to be done to realise it.

For investment to be truly stimulative of growth, it needs to be balanced across a variety of sectors. In an apt illustration, it is all very well to spend lots of money on building power plants (which shows up as investment spending), but power plants cannot contribute to growth if there is no fuel to run them. The lack of balance is a clear threat to the recovery, ICOR-based optimism notwithstanding. This must be a policy priority if the potential has to be realised. In this context, the fiscal response becomes critical. The government drew some satisfaction from the fact that the eventual fiscal deficit for 2012-13 was lower than the revised estimate presented along with the Budget for 2013-14. But, unquestionably, the government needs to spend more on asset creation, which in turn can catalyse private investment spending. In this lie the real seeds of a recovery.