Browning of the economy

Browning of the economy
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First Published: Tue, Dec 21 2010. 11 32 PM IST
Updated: Tue, Dec 21 2010. 11 32 PM IST
After independence, the Indian economy was built on the simple but sensible premise that asset-based capacity creation is the prerequisite for economic growth. Hence, the kind of industrial strategy that was followed. Public investment created greenfield capacities across sectors, and over space.
It is hard not to notice how all this has changed after economic reforms and liberalization. In the 20 years of reforms, there have been very few greenfield projects and initiatives in any of the basic and capital goods sectors—be it steel, oil, cement or other basic goods. Almost all the capacity creation in these sectors happened before the 1990s or just around that time.
After reforms, whatever capacity has been added in these critical sectors has been through brownfield expansion. Productivity and efficiency gains have aided growth in the last two decades. But these cannot be substitutes for capacity creation. Capital formation at the macroeconomic level is not quite the same as capital expenditure.
There are no two ways about the fact that greenfield investment is more beneficial for the Indian economy. Not only does it result in asset creation, it also has a much higher multiplier. Through that it generates a much greater level of income in the economy.
To the extent that construction is a large part of greenfield investment, the wage-goods intensity of the expenditure is higher, aiding income distribution as well resulting in a much more broad-based demand in the system.
It also has major implications on regional disparities. Brownfield investments tend to accentuate regional gaps as these concentrate investments in existing growth clusters. A greenfield expansion, in comparison, has a spatial spread to it which is critical for distribution of growth across the economy.
While the preference of private sector companies for brownfield is understandable, this trend has reached such levels that the government itself is betting more on brownfield expansion. The classic example is the steel ministry, which hopes to achieve the targeted production capacity of 120 million tonnes by 2012 largely through brown-field investments. Not surprisingly then, a PSU like SAIL plans to spend Rs70,000 crore to augment its annual production by about 10 million tonnes in the next three years.
Over the next five years or so, brownfield expansion of various firms in the public and private sector is likely to add 40 million tonnes of capacity, driven almost entirely by technological upgradation in the existing facilities. Greenfield will account for one-fourth of this.
The implications of low capacity creation, especially greenfield, are just beginning to show; the economy has become a net importer of steel; and oil demand growing at 40% over the next decade and domestic supply by 12% will mean the Indian economic growth will be hostage to global oil price movements.
Already, the infrastructural deficit is a binding constraint. Add to that the massive emerging supply-side constraints in basic and capital goods, and it would imply huge national cost and forgone industrialisation. The India story may end rather abruptly.
From the numbers, it would appear that reforms and liberalization have acted as a drag on greenfield investments. It is strange but true that not one large greenfield project has come up in the basic goods sectors after liberalisation. Indeed, Indian companies have spent more resources acquiring companies abroad, a form of brownfield investment, rather than investing in green-field within the country.
It is also a fact that much of the foreign direct investment since the 1990s has gone into mergers and acquisitions. Greenfield investment has formed a very small portion of total FDI flows.
A possible structural reason for brownfield getting primacy is that not many banks and financial institutions are keen to finance greenfield projects. Erstwhile development financial institutions such as IDBI, ICICI and IFCI have been transformed into banks. In their earlier avatar, these were the real promoters of all the business groups that we see today. They funded all green-field expansion across the country. As banks, they are finding it more lucrative and less risky to fund retail at the short end than projects at the long end.
At a more systemic level, the most critical reason is the delay and complexity involved in getting approvals to set up greenfields. The inordinate delays in land acquisition faced by domestic and foreign companies have hindered the process. This calls into question the reduction in the nature and extent of government intervention that is now taken for granted. Earlier governments held up private investments by having the power to sanction capacity; now it is holding back private investment, domestic and foreign, through approvals for land, water, environment et al.
This only highlights the need for a second round of reforms, primarily at the state level. The system has so far moved from “control” to “regulate”; now we have to move from regulating to “enabling”.
Haseeb A. Drabu is an economist , and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comment at haseeb@livemint.com
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First Published: Tue, Dec 21 2010. 11 32 PM IST