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Indian Economy: The sinking feeling

Jun 13, 2001

Even though many continue to remain optimistic about India's prospects over the next few years, immediate worries are mounting. Growth in industrial production (measured as the percentage change in IIP) has declined to a rate of 2.7% YoY in April. This is in line with a declining trend, which saw IIP growth fall from 12.7% in FY96 to 6.6% in FY00 and 5.0% in FY01.

A look at the numbers for April paints a grim scenario. Save for mining, the other sub-components of the index viz. general, manufacturing and electricity have recorded a decline in growth.

What ails the Indian industry? Domestic demand, both investment as well as consumption demand, has been sluggish. This is largely due to the fact that agriculture, which accounts for nearly two thirds of the population, has not fared well in the previous year. Its performance over the last several years has at best been erratic (Read more on Indian agriculture). With such a large base going slow on consumption, the impact was only to be felt sooner than later. Sluggish prospects for domestic demand have in turn taken their toll on investment activity.

Moreover, investment activity in the infrastructure sector, which has the potential to kick off the much-needed virtuous circle, continues to be mired in political and bureaucratic controversies. Although the money flow into the sector has shown a rise, it is much below anticipated/required levels.

The April numbers are further suppressed by the sharp slowdown in growth in exports to 2% as compared to 30% a year ago.

How does this virtuous circle work? Lets take the example of building a road, which leads to

  • Increase in employment
  • Increase in demand for cement and steel
    This further contributes to:
  • Increase in industrial productivity as better roads reduce time and cost of transport
  • Increase in employment, which would generate more consumption demand
  • Increase in revenues of cement and steel sectors, which again would probably translate into better remuneration for their employees (this will impact consumption demand).
  • As the demand scenario improves in the steel and cement sectors, investment activity will pick up.
  • As more and hopefully better-paid employees step up their consumption, the need to make investments to meet fresh demand will pick up across industries.

The structure to usher in this virtuous circle is already being put in place. Interest rates are being lowered, housing construction activity is being encouraged and most importantly large road construction projects are being undertaken.

FY02 has started on a very dull note. However, with a likelihood of a normal monsoon and pick up in investment activity in the infrastructure sector, things may not turn out to be as bad as they seem now.

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