Broadening The Market

There is no let up in the downslide of industrial output. The index of industrial production (IIP) grew at a lower clip of 7.0 per cent in April-February 1996-97 down from 11.7 per cent in April-January 1995-96. The tempo seems to have slowed . And not many are ready to bet on the trend in the near future.

The slowdown is a continuation of the downtrend two years ago. In fact, since 1992-93, the IIP picked up momentum after the pangs of adjusting to the reforms were over. The growth rate then was 2.3 per cent and by 1995-96 it reached 11.7 per cent. Industrial output has moved in tandem with growth in manufacturing and electricity generation. In 1995-96, manufacturing rose by 13 per cent and electricity generation by 8.2 per cent while IIP was up 11.7 per cent. In the past too, when manufacturing grew a minus 0.8 per cent in 1991-92, IIP rose a bare 0.6 per cent. This is because manufacturing has a high weighting of 77.11 per cent in the index.

 

It seems capital goods, consumer durables and consumer goods sectors have propped up industrial production in recent years. Three years ago the IIP rose by 9.4 per cent fired by a 24.8 per cent growth of capital goods sector. In 1995-96 the consumer durables sector grew by 37.1 per cent propelling IIP growth. In 1996-97 ( April-January) both capital sector (10.3 per cent) and consumer durables (5.1 per cent) have shown a heavy fall in their growth rates. That gives rise to the fear that since liberalisation industrial growth has been led by capital goods and consumer durables that cater to the consumption basket of a narrow social base that does not grow fast enough.

Demand for these goods is substantially driven by the upper middle and middle classes. The recent slowdown, therefore, has a lot to do with the failure of these segments to grow as expected. The extremely narrow social base (middle classes accounts for 10 to 15 per cent of the Indian population) and a slow growth of this base have exerted a weak influence on the market and therefore the demand side of the economy.

The industrial sector that built up capacities in the goods catering for these classes has been stuck with capacity underutilisation and high inventory pile-up in the face of weak demand. Inventories as a percentage of net sales of top Business Standard 1,000 companies accounted for 18.4 per cent, a one percentage point less than the previous year. The market has to change from being class-based to mass-based for the revival to set in. So it is plausible to assume the current slowdown is more a demand determined phenomenon than a supply induced one.

It has become commonplace now to blame slack growth in credit (supply side) for industrial slowdown. The assumption is that there was demand for funds from the industrial sector but credit flow was not enough. The reasons cited are that the banks worried over the growing non performing assets (NPAs), played on the safe side by investing a substantial part of their incremental deposits in government securities that led to the credit crunch.

The contention though plausible is only a partial explanation. Non-food bank credit (to the commercial sector) rose by 30 per cent or Rs 45,775 crore in 1994-95, by 23 per cent or Rs 44,938 crore in 1995-96 but slowed down to 10 per cent or Rs 69,776 crore in 1996-97. It is therefore tempting,to associate the industrial slowdown with a slowgrowth in credit flow. Note that the growth in credit flow has slackened but the supply was on. Similarly, gross bank credit to industries rose by 22.2 per cent in 1995-96, 27.1 per cent in 1994-95 but 2.3 per cent in 1993-94.

Not many bought the credit crunch hypothesis behind industrial slowdown. Banking circles feel that it has to be seen in the context of the entire gamut of economy wide demand and supply factors. They feel the credit crunch is a misnomer, for what is obviously a situation of low credit offtake in the past two years. As a banker maintained that the credit offtake was small not because of high interest rates but because corporates thought eligible by the banks were not willing to borrow and those corporates willing to borrow were not considered eligible for the high risk involved. The bankers did not want to suffer from the fallout of the wrong judgment in lending. The strict vigilance on the NPAs is the reason, he says. The result was a slow growth in credit supply that had only a partial impact on industrial sector.

Many bankers feel too much has been made of high interest rates. In any case, blue chip companies could raise finance at low interest rates in the international or domestic market. M S Verma, chairman, State Bank of India, lends credence to the claim of weak demand hypothesis. He says, The recent cut in PLR by the bank did not push up demand for credit significantly in April and May of the current fiscal, presumably because credit demand did not depend solely on interest rates but also on several other factors including the general state of the economy.

In a recent research paper economists Sumon K Bhaumik and Hiranya Mukhopadhyay have argued that the credit crunch hypothesis provides only a partial explanation for the industrial recession. Demand for bank credit might have played an important role too in determining the actual disbursement usage of bank credit in the private sector. The increase in capital offtake depends not only on the cost of capital but also on the returns to investment. The authors have tried to show that the supply of credit is sensitive to the risk premium. The higher the risk premium the lower (the growth rate of) credit provided by commercial banks.

Therefore, the reason for the industrial slowdown has to come from the weak demand hypothesis and the narrow social base of the middle class that grows slowly. On the demand side, the major reason was a fall of 0.4 per cent in the agricultural output in 1995-96. The farm sector exerted downward pressure on demand for industrial goods in the absence of growth in agricultural incomes.

Slowdown in trade has acted as a hindrance to the revival of the industrial economy. In 1996-97 exports rose by a mere four per cent as against 21.4 per cent in dollar terms in 1995-96. This was largely because of the general sluggishness in the world economy. Export income accounted for just 8.8 per cent (9.7 per cent) of the gross domestic product (GDP) in 1996-97. The slowdown in exports affected incomes in general aiding the weak demand. In 1996-97 , total imports rose by six per cent in dollar terms down from 26 per cent the previous year.

The tardy growth in imports exerted a downward pressure on the growth of capital goods industry in particular. In the past imports and capital goods have grown in tandem. Capital goods industry grew by 10.3 per cent (18.0 per cent) during April-Jan 1996-97. Imports account for 10.2 per cent of GDP. All these forces have added to the weakening of demand and affected the real sector of the economy.

So, what are the prospects for revival of the industrial sector? Not many are willing to indulge in the numbers game. Yet, the fact that the economy has been growing at more than six per cent a year during the last four years shows optimism. At no time in the past 50 years has the economy shown such resilience despite a fall in agricultural growth in 1995-96. Agriculture in 1996-97 rebounded and is all set to grow in the current year. That may brighten the prospects of the industrial economy as rising incomes in the rural sector will broaden the market for industrial goods in spite of the time lag involved. Political uncertainty has been substantially discounted. Liquidity has improved thanks to a cut in CRRs and SLR. Interest rates have eased too. Banks are keen to get out of the overbought position in government securities.

The real canker is weak infrastructure. Unfortunately, efficiencies of infrastructure investment have been slow in materialising. Yet most are bullish. That means a boost to trade with its positive fall out on industrial sector through revival of demand. Yet the real stability to the industrial sector will come when the market for goods and services broadens and deepens to include a wider profile of population. It just would not do to build industrial growth on a slowly growing middle class and building up capacities in a small number of goods. That is the lesson of the current slowdown. Not many have bought the credit crunch hypothesis behind the industrial slowdown. Banking circles feel...the credit crunch is a

misnomer for what is obviously a situation of low credit offtake in the past two years.