Returns on investment could rise as productivity looks up

Returns on investment could rise as productivity looks up
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First Published: Fri, Feb 29 2008. 12 09 AM IST

Updated: Fri, Feb 29 2008. 12 09 AM IST
New Delhi: The return on every rupee invested by Indian manufacturing companies is less than half the average for the economy, but will likely increase in future on account of improving productivity in its operations, according to economists.
Demand-driven: The higher growth rate of investment in manufacturing may be on account of firms building up capacity anticipating demand. (Photo: Ramesh Pathania/Mint)
Incremental capital-output ratio (ICOR), a measure of the amount of additional capital needed to increase output by one unit, was 8.9 for manufacturing during the 10th Five-year Plan (2002-07) compared with 4 for the economy.
A low ICOR indicates more efficiency because it means that lesser capital is required to increase output.
While sectors such as manufacturing and mining had high ICORs during the 10th Plan, the services sector’s ICOR was lower than the economy’s average of 4. Services such as banking and telecommunications make up around 62% of economic activity, which means that India has an ICOR rate lower than that of manufacturing-oriented countries such as China, where the ICOR is 4.3.
Within services, the survey noted, construction and trade and hotels had ICORs of 1.2 and 0.7, respectively. Other segments of services sector such as financial services had an ICOR of 3.3 and communication had an ICOR of 0.6.
The Economic Survey picked out trade and hotels and construction as two components of the services sector which could generate higher employment with little additional investment.
“(The) ICOR trend should be declining as we are seeing productivity enhancements in some sectors such as auto parts. However, capital infusion may raise ICOR in the short run,” said D.K. Joshi, principal economist at credit rating agency Crisil Ltd.
Growth rate of capital infusion, or investment, in manufacturing during the 10th Plan at 33.6% outstripped that of other sectors. The growth rate of investment across sectors during the same period was 15.9%.
The higher growth rate of investment in manufacturing could be on account of companies building up capacity anticipating demand fuelled by a booming economy, the survey said. Economic growth averaged 8.7% over the last five years, said finance minister P. Chidambaram on Thursday, after placing the Economic Survey in Parliament.
Another reason for the high growth in investments could be an indirect outcome of rigid labour laws in India, said economists. “Anecdotal evidence suggests high capital intensity in manufacturing could be because of shortage (of) skilled labour or the environment is not conducive,” said an economist at a bank who did not want to be identified.
A survey on the Indian economy brought out in 2007 by the Organisation for Economic Co-operation and Development (OECD) supports the anecdotal evidence that manufacturing veers towards high capital intensity, which is anomalous in a country with low labour costs.
Indian firms rank labour regulation and restrictive exits as the most important barriers to investment and expansion, the OECD survey said.
Some economists, however, cautioned in the absence of ICOR data over a long period of time for different sectors, it would be difficult to draw meaningful conclusions. Pronab Sen, chief statistician of India, who oversees the government’s data collection work, echoed similar sentiments.
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First Published: Fri, Feb 29 2008. 12 09 AM IST