The task ahead

For growth to revive, capital efficiency must improve

When the finance ministry presented its Economic Survey in February 2013, it projected India's gross domestic product (GDP) to grow in the range of 6.1 to 6.7 per cent during 2013-14. This was Raghuram Rajan's first and last Economic Survey as chief economic advisor. His views clearly turned pessimistic during the course of the year; the Reserve Bank of India's most recent growth forecast even as late into the year as January 2014 was five per cent. The advance estimates published on February 7 put it at 4.9 per cent - not too far out. However, last Friday, the quarterly estimates for the third quarter, October-December, put it at 4.7 per cent, taking the tally for the first three quarters of the year to 4.6 per cent, making even five per cent for the year a rather tall order and now expected by nobody outside government. Five years ago, the government went into the elections with growth rates flirting with all-time highs. This time around, in sharp contrast, comparisons for many sectors - particularly manufacturing - are being made with all-time lows.

What went wrong and how policy failed to respond have been the subject of intense debate, including on these pages. The government's steadfast insistence that this fall from grace was largely the result of global forces beyond its control has convinced few. While global shocks have certainly contributed to instability during the current year, it was the economy's vulnerability that resulted in the massive disruption that it saw during the May-September period. However, more than this episode, the problems that have plagued policymaking and, consequently, impacted growth performance are reflected in the elevated incremental capital-output ratio (ICOR), which serves as a rule-of-thumb measure of capital efficiency. The ratio of the share of gross fixed capital formation in GDP, or the investment rate, to the growth rate, the ICOR for the first three quarters of the current year is just above seven, a far cry from the levels of about four that were seen during the high-growth phase of 2003-08. This indicates that capital efficiency has dropped dramatically during this slowdown, significantly aggravating the impact of declining investment rates. All the concerns about slow clearances and approvals, huge time overruns on important infrastructure projects and the resultant imbalance in capacities across sectors - power generation and coal are clearly the most vivid example - are reflected in the translation of a still relatively healthy investment rate of 32.4 per cent in the first three quarters into such a poor growth rate. The return on capital employed at the aggregate level is far from satisfactory, particularly when compared to the achievements of not so long ago.

The next set of policymakers need to be realistic about the constraints that the economy is dealing with and the huge push that will be needed to deal with them. Structural reforms are a long-haul process, requiring much up-front effort and yielding their full dividend years later. The 2003-08 growth dividend came after 12 years of plugging away by three different formations in government to put the pieces in place. Sustained growth requires sustained commitment and sustained action on reforms.