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Industry buoyant on selective investment

Subir Gokarn

It is now pretty obvious that Indian industry is doing a lot better this year than in the previous two. The Index of Industrial Production grew by 5.02 per cent in 2000-01 and by 2.69 per cent in 2001-02.

Its largest component, manufacturing, grew by 5.35 per cent and 2.85 per cent, respectively, in these two years. During the first half of this year (April-September), these two indices grew at annual rates of 5.20 per cent and 5.26 per cent respectively, but with clear signs of acceleration each month.

However, looking at the more disaggregated numbers, it is also pretty obvious that the acceleration has been selective.

The entire acceleration has been the result of buoyancy in 6 out of 17 industrial categories - food products, basic chemicals, basic metals, beverages, transport equipment and textiles.

These industries account for about 50 per cent of the manufacturing basket in the IIP, but for all the growth in the first six months of the year.

The recovery so far has clearly not proved to be a rising tide, carrying all boats with it.

Many people have been arguing for a long time that the long-term prospects for Indian industry are critically dependent on a whole series of reforms being implemented.

Emphasis may vary, but the range typically covers labour, bankruptcy and exit, infrastructure and the end of reservations for small-scale industry.

Sometime last year, 'pump priming' entered the policy debate.

Protagonists of pump priming suggested that, in the absence of any foreseeable progress on many of these reform fronts, a large increase in government spending would at least be a short-term remedy for industrial stagnation.

The debate petered out without a clear resolution, but it did focus attention on an important aspect of managing the reform process.

In any process of restructuring, it is essential to keep the business growing. Fiscal compression during the early 1990s had resulted in a contraction in a significant component of demand for industrial products.

The hopes that this would be more than made up for, by an expansion in private demand resulting from higher investment rates and more consumption, were not realised.

Without diminishing the importance of the problems that need to be addressed by the reforms referred to above, the pattern of industrial activity over the last three or four years reveals how important it is to keep the demand side up even as we struggle to deal with the longer-term, essentially supply- and cost-related problems.

This is, perhaps, the most basic lesson of macroeconomic policy, which seeks to smoothen out short-term fluctuations in economic activity.

It may have well been forgotten in the relatively longer-term emphasis that a reforms programme inevitably has to put.

A second lesson coming out of the same body of knowledge, is the benefits that low interest rates can generate for the economy, particularly in a comfortable inflationary situation.

If low inflation reflects excess capacity and intense competition amongst producers in the economy, monetary policy faces relatively low risks of spurring inflation with an aggressive push for lower interest rates.

In the current Indian context, the virtuous combination of public spending and easy money is clearly visible.

The highways programme, apart from any long-term benefits it will have, is a classic short-run instrument for demand management. It creates a demand for industrial goods directly, spread all over the country.

It puts income in the pockets of relatively lower-income groups, which means a guaranteed increase in spending on consumer goods.

Particularly in this year, the geographic spread of the programme probably contributed significantly to mitigating the impact of the monsoon failure by generating off-farm employment opportunities.

The low interest rates have had their most visible impact on consumer financing for housing, automobiles and consumer durables.

Banks and other lending companies are seeing virtually all their growth in business coming from these activities.

If one treats housing as being a legitimate form of investment - the creation of a long-lived asset - then it would be unfair to make the claim that the interest rate regime is not stimulating investment at all.

It is, of course, difficult to make a one-to-one correspondence between the macroeconomic pattern just described and the pattern of industrial recovery described a little before. But, some of the links seem quite obvious.

Metals are strongly linked to construction and to transport equipment, which is itself linked to construction and low interest rates.

Foods and beverages are linked to expanding consumption spending. So are textiles, which received an additional boost from buoyant exports during this period.

The key lesson, then, is that the government has been successful with the macroeconomic policy combination in boosting demand. In a sense, this can be interpreted as a vindication of the pump-priming argument.

Demand management, over which the government has some degree of control and is relatively less vulnerable to political strife, may be effective as a substitute for the far more difficult, contentious and time-consuming supply-side issues, that have been on the reforms menu for a long time, but never been ordered.

This is a lesson that appears to have been quickly absorbed by the government. The recent revival of the river linkage scheme can be directly linked to the overall positive impact that the highway programme has had, both for the government and the economy.

There are many questions about the social, ecological and environmental impacts that will inevitably come up, and may not be effectively addressed as the debate on the proposal evolves.

But, from the perspective of this article, what is important is that its re-emergence reflects a belief on the part of the government that large, nation-wide investment programmes, with a significant component of public funding, may actually keep the momentum going for industry and offset the lack of progress on the more fundamental reforms.

There can be arguments on this. Some growth, wherever it comes from, is better than no growth. You can't sit around waiting for reforms for ever.

Better to do something that generates returns quickly, without worrying too much about long-term consequences.

However, to be sustainable, growth must emerge from investment in areas in which the economy is competitive. This will only be made possible by reforms.

Growth that results from short-run demand management may provide relief, but may well be permanently destroying the competitiveness of industries, which do not directly benefit from it.

On the whole, we would rather have some growth than no growth. But, sustainability eventually depends on competitiveness.

India's reforms may historically have been completely motivated by crisis, but the essential insight from the 'keeping the business going' approach is that every good patch provides an opportunity for pushing through significant changes. Will this recovery, however mild, be taken advantage of?

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