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Economy: Two things to watch - Views on News from Equitymaster
 
 
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  • Apr 26, 2001

    Economy: Two things to watch

    Over the last three years or so, the Indian economy has witnessed a slowdown in growth. Actually, stagnation would be a better word for it. Surprisingly, all three sectors viz. agriculture (24% of GDP), industry (21.9%) and services (54.2%), have failed to accelerate. Infact, save for manufacturing (which has stagnated), the other sectors have witnessed a slowdown in the growth rates.

    India may have done well for itself in the context of a global slowdown. By some accounts we are among the fastest growing economies in the world. But, we are nowhere close to achieving sustainable levels of 8% growth and above. The Prime Minister can talk of higher growth rates but facts state otherwise. The slowdown is fundamental, as is reflected in the slowing rate of capital formation. Moreover, growth in the capital goods sector, another indicator of economic activity, has recorded a growth of just 2.1% during the first eleven months of FY01 (6.6% in the corresponding period last year). Compare this with the 12.7% annual growth recorded in 1999 and the gravity of the situation becomes apparent. Any speculation that imports may be meeting the demand for capital imports too can be put to rest by taking a look at the declining non-oil import numbers (down over 12% YoY in February 2001).

    The purpose of this article however is not to generate gloom. We will look at two factors that will probably play a significant role in the turnaround in the economy and support a higher growth rate in the years to come.

    First is the booming construction sector (5.2% of GDP), which has continued to register growth despite the overall slowdown. There are two ways to look at this. First, increasing construction activity gives the picture of more employment, more consumption of cement, steel and the like. This will generate demand in the economy. Second, infrastructure will account for a large part of the construction activity. More roads, better ports et cetera will benefit the economy by supporting a higher level of economic activity.

    Second, and a more important factor, is the softer interest rate environment that has been ushered into the country (though its sustainability is subject to the government's borrowing appetite, but that is better left for discussion at a later date). Lower rates impact the economy in several ways. One cost of capital declines, thus improving profitability and making investment activity relatively more attractive. Two, lower borrowing costs support a higher level of consumption activity as financing costs decline.

    Both these factors have the potential to kick off an urgently needed virtuous circle: more demand for goods and services higher investment activity to meet this demand rise in incomes as employment rises more consumption as more people are employed (this in turn supports higher investment activity). But the small size of the overall construction sector and the recent cut in interest rates may not have an immediate impact on growth. However, as lower rates trickle to the bottomline and spur investment activity and the construction industry gains momentum, India stands to benefit significantly.

     

     

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