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Opinion | Is India really making better use of productive resources?

Sluggish investment demand in India is more likely a result of idle capacity than capital efficiency

There has been a controversial yet useful and important debate going on between economists and chartered accountants (CAs) in the country. A total of 108 economists and social scientists raised concerns about frequent and inexplicable revisions to gross domestic product (GDP) growth numbers and over the withholding of data on employment generation. Meanwhile, 131 CAs defended the GDP growth revisions as inevitable consequences of adopting methodologies followed elsewhere in the world. Over the weekend, veteran journalist T.N. Ninan stirred the pot with his column in Business Standard which raised the tantalizing prospect of India having achieved capital efficiency nirvana already.

Capital efficiency is an alluring explanation because it can explain weak employment generation, sluggish capital formation, and yet decent economic growth rates. At the same time, oodles of idle capacity can also explain all the three phenomena. So, are we simply going through a long disinflationary phase of modest growth because far too much capacity has been created than can be put to use—given regulatory and policy tangles as well as the weak underlying demand caused, among other things, by tepid credit growth? Available evidence points to the possibility that there is excess capacity rather than capital efficiency.

The first place to look for evidence of a productivity boom is profits.On this score, data on productivity in India is notoriously difficult to find. The Conference Board, an American research group-cum-think tank, produces international labour and productivity comparisons. India’s total factor productivity (TFP) growth has not been bad in recent years. But, the country had experienced higher TFP growth in the boom years preceding 2008. Indeed, there is nothing in the near-three decade long data on TFP growth for India available from the Conference Board to suggest it is anything other than cyclical.

Let us turn to profits. In January, The Economic Times published a report on the profit-to-GDP ratio of Nifty 500 companies having hit a 15-year low, citing research by Motilal Oswal. Of course, this would have included the financial sector—both of the banking and of the non-banking variety.

The Reserve Bank of India publishes quarterly and annual data on the financial parameters of non-government and non-financial companies. Data for the last five years suggests that the top-line and bottom-line of non-financial private corporations have grown steadily, but there is nothing in the data to suggest that a new, structurally better growth path for corporate profits and sales lies ahead. Profit margins are steady and not spectacular.

If capital efficiency and productivity were underpinning growth, then corporate sentiment should be buoyant. The quarterly surveys conducted by the RBI on industrial outlook (covering over 1,200 manufacturing companies) shows that their assessments are rather subdued in comparison to the ebullience felt before 2008. The same survey asks the companies about their capacity utilization levels compared to the average of the previous four quarters. The response is negative. That is, capacity utilization levels are below the average of the previous four quarters. In the years before 2008, this was strongly positive.

IHS Markit India Business Outlook for February published on 12 March shows that optimism among Indian businesses—both manufacturing and services included—is stuck at low levels. The net balance of sentiment is near the one-and-half year low observed in October 2018. In sum, several datasets and sources point to the possibility that India is experiencing economic uncertainty rather than economic efficiency.

In general, one must place a higher burden of proof on those claiming the dawn of a new era, because the costs of policy decisions based on such a premise can be substantial and incurred over a longer period if the premise turns out to be false, as the developed world learnt in 2008 and has unlearnt since.

Textbook economics would suggest that the time is ripe for a fiscal stimulus. Private sector credit demand and supply are weak and there is spare capacity. But, India’s fiscal policy is not exactly tight, even if it may appear so based on official data. Much of the fiscal deficit has been farmed out to the books of government enterprises rather than being reflected in the accounts of the government.

State governments, on their part, might have pulled back on their expansive spending of the last few years in 2018-19. The combined fiscal deficit of the Union and state governments has been steady in the last several years. India’s economy has not exactly suffered from fiscal retrenchment in the last three years. Calls for further fiscal stimulus must be laced with caution.

That said, the economy is in need of intervention, not of the fiscal variety but of the leadership variety. Post elections, it needs leadership that can quickly assess the costs and benefits of procrastination versus swift action, and move to act decisively with the long-term national interest in mind rather than the next set of state polls or the Lok Sabha elections due in 2024.

*These are the author’s personal views. V. Anantha Nageswaran is the dean of IFMR Graduate School of Business (KREA University)

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