The Puzzle Of Growth Recession

large corporations, b) declining sanctions by financial institutions, c) a fall in non-oil imports, and d) company first half-year sales results (as reported in the media). This duality/dualism in the economy between industry in general and the large corporate sector has been a puzzle during the second half of 1996-97.

The last few years have seen the transition of the economy to a higher growth path following from the various policy reforms undertaken since 1991-92. These reforms also have their effect on the macro-economic interrelations in the economy. The removal of controls has to a significant extent reduced the protection provided to large corporate industry, putting competitive pressure and providing increased opportunities. This has forced corporations to rapidly achieve economies of scale by building capacity in anticipation of future growth, and to upgrade products and plants to meet potential competition. The animal spirits unleashed by the early spate of reforms, perhaps also resulted in over-optimistic forecasts of demand growth for new and/or upgraded projects. A hump is demand for durable goods and slow adjustment in real interest rates accentuated the mismatch between capacity addition and demand growth. The deterioration in non-transferable infrastructure has raised its effective cost. This in turn has

 

put upward pressure on costs of production. The supply problem arising from import controls on agricultural goods, which artificially creates non-tradable goods, has added to this cost pressure. Though the relative price of manufactures has fallen sharply during 1996-97, the fall was probably less in the large capital intensive sectors. This combination of falling demand and rising (infrastructure) input costs resulted in a Keynesian excess supply situation for these sub-sectors, which can plausibly be labelled a growth recession.

The slowing of industrial growth in the first half of 1996-97 was clearly attributable to a dramatic slowdown in the growth of the electricity and mining sectors. During the first nine months of 1996-97 electricity production has grown by only 3.7%. Given the high correlation of 0.67 between manufacturing and electricity, it was somewhat surprising that manufacturing production was apparently un-affected by the slow growth in electricity production. It is likely that own account electricity generation has substituted for the lack of generation by electricity boards but it provides no relief from the rising effective cost of electricity.

Within manufacturing, an aspect of the macro puzzle was an acceleration in the growth rate of capital goods production to 18.2 in the first half of 1996-97. In complete contrast, import of capital goods declined by 4% in the first half of 1996-97. This showed the strength of the domestic capital goods indsutry, which was initially subject to the fastest tariff reduction so as to ensure quick recovery of private fixed investment. The move to more uniform tariffs on manufactured goods has contributed to the removal of anomalies and to the growth of capital goods production.There has, however, been a slowing down in the growth of capital goods production in the third quarter of 1996-97. This has happened despite an easing of monetary growth during 1996-97 and a decline in market interest (call money and T-bill rates), partly because interest rates for private borrowers lagged these developments.

Among the identifiable sources of fall in demand for the corporate sector the most important one related to the pent up demand for higher quality consumer durable goods. The de-licensing of investment in durable goods and the decontrol of imports of parts for the same, led to a boom in investment and production of consumer durable goods, culminating in the phenomenal 37 per cent growth in 1995-96. The decline in growth of consumer durable goods to 9.8 per cent in the first half of 1996-97 and further to 6.5 per cent in the first nine months of 1996-97, suggests that the pent-up demand for higher quality durable goods has been met. Further growth will depend on increased cost competiveness or introduction of new products. The former requires fuller exploitation of the comparative advantage that India has in production of labour intensive parts.

The above analysis leads directly to a number of Policy conclusions - both Dos and Donts. Given the very circumscribed and limited sub-sector of the economy subject to the growth slowdown, a conventional aggregate growth stimulus would have been (and is) the worst policy response. Thus for instance a higher fiscal deficit, providing such a stimulus would have aggravated the infrastructure problem and the cost push elements and raised the inflation rate considerably. In contrast the effect on aggregate output would be limited to the effect on the large corporate sector. Thus any inflation output trade-off from such a policy would be very limited, and possibly illusory.

The appropriate policy response had (and has) several elements. The infrastructure constraint was addressed by a number of policy reforms and initiatives designed to ease the entry of the private sector in the provision of these services. The second important problem was the lag in response of interest rates to the easing monetary policy and falling demand for credit. A number of procedural and other actions were taken culminating with more fundamental reforms in the financial sector as per the Credit Policy of April 1997. The 1997-98 budget, one of the most outstanding since 1992-93, cleared the air of pessimistic expectations which hung over the corporate sector in the third quarter of the year. The reduction in personal and corporate income tax rates will not only provide an environment for efficient growth but will also partly address the demand growth slowdown in the corporate sector.

Sustained growth of 7% to 9%, will however require, quicker and bolder action with respect to the electricity sector. The most urgent is the setting up of central/regional/state regulatory authorities which are strong and independent and have the power to discipline the SEBs and to regulate both tariffs and conditions of supply. The second critical need is for reforming the State electricity boards themselves. The faster and deeper the policy reforms in the infrastructure sector, the quicker will be our approach to a high growth (employment, output), low inflation, internationally competitive economy. Flexible and speedy policy response and a pragmatic approach to reforms is also needed to generate new leading sectors and maintain high growth.A combination of falling demand and rising input costs underlies the growth performance of 1996-97, says Arvind Virmani