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Economy: Investment led growth

Sep 3, 2007

The GDP estimates for the first quarter of FY08 released by the Central Statistical Organisation (CSO) corroborate the patterns noticed in the Index for Industrial Production (IIP). Though consumption has reduced its share of the first quarter GDP from 73.3% in 1QFY07 to 71.5% in 1QFY08, building of actual machines and factories (fixed capital) has consistently improved its ratio to GDP over the last three years. Significantly, it is the private consumption expenditure that has slipped. A slower growth in the consumer goods sector of the IIP shows the effect of this reduced demand for consumption. Whereas it is the capital goods and the basic industries that provide the raw material to make these machines have been growing despite the general slowdown in all the other sectors of the IIP, all thanks to increased investments across the country.

Overall GDP growth slips
Though retaining its position above 9%, GDP growth for the first quarter FY08 slipped marginally from the 9.6% posted in 1QFY07 to 9.3%. This continues the small decline first noticed in the preceding two quarters (3Q and 4Q of FY07). There is a marginal decline in the manufacturing, construction, trade, hotels and communications sectors. However what is really slowing down the overall rate is the community services segment (accounts for about 15% of GDP). This includes the government, defense, private NGOs, medical and education sectors. As most of these are pre-dominantly in the public sector, fiscal belt tightening affects the incomes and this is borne out by the slight decline in consumption demand in the country. Any increases in accordance with the Sixth Pay Commission in the perquisites and salaries of all these employees should see this slowdown reverse.

However, the consumption data shows some increase in government consumption demand (from 12.5% of GDP in 1QFY07 to 12.7% in 1QFY08) even as private sector has cut back consumption to invest more. The Reserve Bank of India's (RBI) numbers on India's corporate sector show that most companies have retained profits to re-invest. Thus though the government sector has actually stopped pay hikes, but has not been able to stem its rising other expenditure; this situation is confirmed by the increase in internal debt year after year.

Mining and quarrying, though at an insignificant level of 2% of GDP, has also shown listless growth. Coal production has been generally lower in the past few months.

Power brightens the picture
The dark horse in the picture is the electricity sector that has shown a continuous increase over the last eight quarters! As India comes to terms with its inadequate energy supply, the growth probably shows a better and more efficient utilisation of existing resources. The Plant Load Factor (PLF or the capacity utilisation in power stations) has also improved from 71.3% to 83.5% in the same period. With more investments in transmission and distribution lines, the crippling effects of the current energy crunch can be mitigated by reducing technical losses that have spiralled to 15% of the energy produced from the acceptable 5%. As power shortages are about 8%, this improvement will help meet the existing demand for energy even as new capacities come up over the next five years.

A better season for agriculture as the country steps up production of mostly cash crops, has also shored up the growth numbers.

A slight respite ahead
Lower demand for goods, coupled with increased capacities that will come up over the next few months, will see inflation control getting better as manufactured goods prices come under control. Great for inflation, but may be less so for company profitability.

Going by the area sown (5% more than last summer), this season's crop ought to be better than in FY07. Sugar, oilseeds, cotton, and wheat - all last year's flash points on the inflation radar, should have better production figures in FY08. Thus inflationary pressures should remain under check over the next few quarters with international crude oil prices being the surprise element. Lower domestic inflation also benefits exporters to stay competitive. A slower domestic demand can be supplemented by more exports in FY08, especially if the capital account inflows slow down enough for the exchange rate to remain competitive.

Only a resurgent agriculture should keep the real growth of GDP at around 8.5% to 9%, higher than our estimate of 7.9% for FY08, a good growth albeit a tad lower than the 9.4% for FY07.

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