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Recently the rating agency, Fitch, slashed the GDP growth forecast for FY19 of the Indian economy. The Fitch estimates put it at 6.9% from the 7.2% growth projected last December. It is not the only institution that has expressed doubts over the recent economic performance of the Indian economy. Many other are concerned about weakening manufacturing activity, low credit availability from banks and NBFCs, low farm income and weakening rupee value as against the major foreign currencies. The other main concerns have been the weakening domestic demand as well as falling non-oil and gold exports.

Ups and downs of Indian economy

The undergraduate students of economics are often taught that one of the most important factors for high economic growth of an economy is its rate of savings. The students of the 1980s and 1990s were taught that if India could save 20% of its GDP and if that could be properly invested then India could achieve economic prosperity expediently. On the other hand, it was also discussed that if India could save like China, India would attain the status of a developed country. But in a short period of time, India attained a high level of domestic savings (savings of households, corporate and public sector) - as high as 36% or even more in 2006 to 2008. In spite of that, India had invested more than 38% of its GDP in that period. The savings-investment gap was matched by inflow of foreign capital. The gap of savings and investments is generally matched by inflow or outflow of foreign capital. If investment of an economy is less than its savings, there may be outflow of capital to other economies.

GDP rise before global financial crisis of 2008

India achieved its highest economic growth in the period between 2003-04 and 2008-09. It is said that in this period, India grew by around 9% per annum on the back-drop of reform measures taken by the government. The period immediately before 2002 had seen a slow growth due to the Asian financial crisis. When the economy picked up later, trade grew at 16.5% between 2003 and 2008 as compared to 3% per annum in the previous few years. India’s export to GDP ratio reached 25% in 2009 compared to that of 14% in 2002. The Indian economy ran at full speed in that period when loose monetary policies in countries like the US and Japan was adopted and money flowed in the emerging economies like India. Net capital flows to India was $250 billion in 2002 and it climbed to $600 billion in 2007. At that time, a huge investment of around Rs. 2 lakh crore was done in Special Economic Zones (SEZs).

What about the performance of the corporate sector at that time? This has been analysed by Tara and Dhamija in the January 10, 2018, issue of The Economic and Political Weekly (EPW).

The pre-2008 high economic growth was led by the private corporate sector which witnessed a historic performance during that time. What was the source of investment of this sector?  There were broadly three sources of savings in India. The household sector, public sector and the private corporate sector. Earlier, it was the household sector savings that dominated the source of savings. But after 2003, household sector savings began to slow down. Growth rate of public sector savings in that period had been flat. But the corporate sector savings growth took the lead in that period. In that phase, the share of gross fixed capital formation in the country, which can loosely be considered investment, fell but it increased for the corporate sector. The importance of the private corporate sector increased in that period as its share in GDP of the country rose to over 25% in 2007-08 from 19.4% in 2003-04.

Reasons behind high growth of private corporate

Tara and Dhamija pointed out some important reasons behind this high growth. The foremost factor was the availability of a huge amount of credit. In that period, this sector received about 40% of the total banking credit disbursement.

The second factor was the huge inflow of foreign capital. By 2008, the savings picked up to 36.8% and investment reached 38.1 % of GDP. So, the savings investment gap was about 2%. That finance was met up by foreign funds. But total inflow of foreign funds prior to 2003 was about 1% of GDP. But in 2003-08, it increased highly. In 2008-09, it stood at 10% of GDP. This amount was actually four times the savings-investment gap at that time. This implies that inflow of foreign funds - both of Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) in the Indian economy was the most major factor behind its high GDP.

Third, the corporate sector utilised most of the foreign funds in that period. This is visible from the utilisation of external commercial borrowing (ECB) data of the corporate sector. The ECB grew from 20% in 2003 to 30% in 2008. Therefore, the high growth of the private corporate sector in that phase was due to two factors. There had been huge utilisation of both domestic credit and foreign funds. It should be noted that in that period short term loan was flat. The debt-GDP ratio was also not rising as government loan from foreign sources declined at that time.

Indian economy hit by 2008 crisis

In spite of all assurances from the government officials, Indian economy began to suffer after the 2008 global financial crisis. Decoupling theory was propagated by government sources and some economists. They thought that Indian economy had been insulated from shocks of the global economic system. This was due to some factors like absence of full convertibility of capital account, absence of sub-prime related assets, absence of failed financial institutions, low presence of securitised assets, low ratio of external loan/GDP among others. It is true that India did not stumble into a crisis just after 2008. Immediate impact was experienced mainly in the stock market. But after a passage of time, the economy suffered from falling exports to GDP and the corporate sector suffered from falling productivity by sustained fall GFCF and hence low productivity and falling profits.

The private corporate sector has been suffering from low GFCF for long and it is still continuing. The sector eventually lost its position of leadership in driving the economy. This was due to two factors. One is the corporate sector has been highly leveraged since then. On the other hand, the banking industry has been suffering from high NPA. This is why demand for and supply of credit have been subdued for long. This phenomenon has been a drag on the economic growth of India till date.

Low investment or GFCF

The investment situation has been weak in India for several years. But why has this been so? C. Rangarajan, former Chairman of the Economic Advisory Council to the Prime Minister, and former Governor, Reserve Bank of India, wrote in an article in a national media a few months back that highlighted this question. He showed that the household sector and not the corporate sector was responsible for the decline in the investment rate between 2011-12 and 16-17. It is known that growth of an economy depends mainly on utilisation of the existing capacity and also on new investment. If one considers the last half of a decade, it can be experienced that the growth rate has been stable. The average growth rate has been 7.3%.  But now the growth rate has been declining as pointed out at the outset. Another disturbing trend has been the decline in investment rate. In 2011-12, the gross fixed capital formation rate was 34.31% of GDP. By 2016-17, it had come down to 28.53%.

Current nature of savings

The major source of funding investment is domestic savings. So the gross domestic savings rate fell from 34.65% of GDP in 2011-12 to 29.98% in 2016-17. The steepest decline has been with respect to the household sector where the total savings fell from 23.64 % of GDP in 2011-12 to 16.26% in 2016-17. The corporate savings as a proportion of GDP have actually increased by almost 2.5%. The savings rate of the public sector including the general government shows no change. In the case of households, both financial savings and savings in physical assets have declined quite sharply over the six-year period.

Current pattern of investment

Investment (gross capital formation) includes three elements, gross fixed capital formation, change in stocks and valuables (gold). The most important component is gross fixed capital formation which means capital expenditures on machinery and equipment and dwellings.

The gross fixed capital formation rate fell from 34.31% in 2011-12 to 28.53% in 2016-17. Gross fixed capital formation stayed at a little above 7% of GDP. Rangarajan found that recent private corporate sector investment showed in fact a rise from 11.23% in 2011-12 to 12.29% in 2016-17. Therefore, the only sector that appears to have been responsible for the decline in investment is households. The household sector’s fixed capital formation rate has shown a steep decline from 15.75% to 9.1% over the six-year period. Much of the discussion on the slowdown in growth has centred on weak investment demand by the corporate sector. Several analysts have drawn attention to the number of stalled projects. Weakening of the investment sentiment has been interpreted as a failure of the corporate sector to make investment. But this does not appear to be so. In fact, by definition what is not government and private corporate comes under the category of households. Household investment in machinery and equipment came down from 2.96% of GDP in 2012-13 to 1.90% in 2015-16. According to Rangarajan, small businesses have suffered more and invested less.

Why is high unemployment unavoidable in new economic order?

Earlier, when the annual growth of GDP had been 4%, the corresponding growth of employment generation was about 2%. But now India’s growth of GDP is more than 7% but employment generation growth is about 1% or even less. Why is this so? The matter has been explained by economist Amit Bhadury in his article ‘Development or Development Terrorism’, published in EPW on 17th February, 2007. A strategy under which the state allies with corporations to dispossess people of their livelihoods is nothing but developmental terrorism, irrespective of the political label of the political parties in office argued Bhadury.

The huge growth of GDP comes from the rising productivity of labour through higher mechanisation in industrial and other production units. This means the same quantity of labour in the new order increases the volume of products several times. Or one can think that less number of people is necessary for producing the same level of production. Professor Bhadury mentioned an article by Edward Loews published in London Times. This would clarify the logic of higher mechanisation in production.

The Tata Steel had produced 10 lakh tonnes steel worth $8 lakh in 1991 by employing 88,000 workers. In 2005 it produced 50, lakh tonne worth of $50 lakh. But the employment reduced to 44,000. That means production increased 5 times but employment was reduced by 50%. The similar experience happened in a study of Bajaj Motorcycle in Pune by economist Stephen Roch.

Technical changes are inevitable for economic units in the new economic order for survival and getting success in the international market. There are other ways to reduce cost and becoming more competitive. Professor Sunanda Sen in her book ‘Globalization and Development’ (National Book Trust) pointed out some findings from her field survey about the working condition of the worker in the new global order. She wrote in her book, “Levels of security of these workers (on which survey was made), as we found, seem to be low on most count; which include income, jobs, employment, skill, social support, tenure and the like. Permanence of jobs and migrant status seem to be two major factors which weigh (in opposite direction) the overall (composite) level of security for these industrial workers.”