ias-toppers-india-manufacturing
Editorial Notes

Editorial Notes 7th November 2016

Indian Economy: Manufacturing, Growth Output, Pressure on Private Investment.
By IT's Editorial Notes Team
November 07, 2016

 

GS (M) Paper-3: “Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.”

 

The outlook on output’s pretty good

ias-toppers-indian-ecnomy

Introduction:

After the global financial crisis, potential output suffered a setback in most parts of the world.

The underlying cause of the decline in potential output in the developed countries, inter alia, was the collapse of total factor productivity (TFP).

For the emerging market and developing economies (EMDEs), this is mainly attributed to a slowdown in investment while the adverse impact on TFP has been modest.

Indian Scenario:

  • India’s potential output and the corresponding output gap — the difference between what the economy is producing and what it can produce are extremely important for policymaking.
  • India’s potential output has come down to around 7 per cent in the post-crisis period, compared to about 8 per cent during 2003-2008, according to an RBI study.
  • The setback to India’s potential output was explained in terms of significant decline in investment during the recent years, besides some moderation in TFP.

The question that is being asked is simple: Is this a demand-side problem or a supply-side problem?

Pressure on private investment:

  • In India, urban demand has been more or less sustained.
  • Rural demand, which was well above the trend for quite some time, moderated recently following growth slowdown in the agricultural sector due to two consecutive years of a deficient monsoon.
  • Despite several initiatives taken by the Government in the last two years, private investment is yet to pick up.
  • Capacity utilisation in the organised manufacturing sector at 71 per cent is one of the lowest in the last two decades. The crowding-in of private sector investment is yet to materialise despite large capital expenditure by the Centre.

Reasons:

  • In the aftermath of the global financial crisis, the economic recovery was policy-driven rather than market-driven.
  • Growth in the world trade volume/value remained below GDP growth rates. Despite the ultra-accommodative monetary policy pursued by the developed countries, there is hesitant recovery in most parts of the world after nine years of the global financial crisis.
  • Financial flows to the EMDEs have been volatile, impacting financial markets adversely in those countries.
  • Global uncertainties have dented investors’ confidence, particularly in the developing countries. The secular stagnation in developed countries has spilled over to the EMDEs.
  • The slowdown in China has further complicated growth uncertainty in the world in general and in the Asia Pacific region in particular. The EMDEs have entered into a phase of low growth, low savings and low investment trap.
  • Breaking this vicious circle is a daunting task unless structural reforms are undertaken on a priority basis. Global demand is unlikely to accelerate in the near future as the global growth outlook remains sluggish despite a modest recovery in the US economy.
  • The Euro Zone continues to struggle for sustained recovery. Brexit further weakens the prospects of growth in developed countries.
  • The Japanese economy is yet to respond in a convincing manner despite several policy initiatives taken by the government and the central bank after the crisis.
  • Rebalancing of the Chinese economy is perceived as a significant headwind in the short run for EMDEs.

Hence, one would not expect export-led growth in India in the near future although export growth has turned positive in recent months.

What about excess at home?

  • A good monsoon this year will augment rural demand.
  • Urban demand will get a boost due to a pay revision for government employees according to the Seventh Pay Commission and one-rank-one-pension for retired defence personnel.
  • As demand is likely to improve, the slack in the economy may decline and capacity utilisation may increase in the near future.
  • Yet, this has so far not led to any sign of improvement in private investment. In case private investment does not pick up, can we grow at a higher rate? Under these circumstances, is there a chance for India to move in the same direction of China, which is rebalancing from an investment-driven to a consumption-driven economy?
  • Many believe that the Seventh Pay Commission award is growth-positive.
  • Sooner or later, India will have to improve its TFP so that higher growth is feasible with the same level of domestic capital formation.
  • While public investment by the Government would help in this endeavour, existing excess capacity would meet, at least for some time, the growing consumption demand for a host of commodities such as FMCG, housing, white goods and so on.

The right combination:

  • The Goods and Services Tax, the opening up of the economy, financial inclusion and a whole host of reforms initiatives by the Government can transform the economy in a big way in the next two to three years.
  • A combination of right policies, at the right time, even in an atmosphere of adverse global developments, can insulate the economy from global uncertainties.

Conclusion:

  • The investment climate in India is much better today than it was a few years ago. Foreign direct investment is accelerating. Foreign investors see India as a preferred investment destination.
  • The Government is committed not only to fiscal consolidation but also to structural reforms, both in the factor market and the product market.
  • The new generation of young people, once employed, can steer the growth impulse through consumption rather than through savings. Therefore, a better option to accelerate growth is to increase productivity rather than anticipate a higher level of investment. This does not mean investment should be ignored.
  • One would expect higher growth with the same level of domestic capital formation even in a situation of stagnant savings provided TFP improves, thereby raising the potential output to the pre-crisis level.
  • India’s potential output is poised for improvement, mainly driven by structural reforms by the Government. If the negative output gap persists, the RBI may continue with an accommodative monetary policy for some more time, provided the CPI inflation stays under control.
[Ref: Business Line]

 

GS (M) Paper-3: “Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.”
GS (M) Paper-3: “Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.”

 

India should focus on domestic market to boost manufacturing: Crisil

ias-toppers-india-manufacturing

Introduction:

  • Maximum possible growth for the manufacturing sector under the ‘Make in India’ will be realized when the country strikes a balance between export-led and domestic-demand led growth.
  • The evidence of this type of growth can be seen in countries opted for dual path.
  • India will need to nurture its export potential to make its goods competitive, yet lean on fast-expanding domestic demand to promote its manufacturing sector.

Challenges:

  • Free trade has benefitted both importing and exporting nations at an aggregate level, even though not every advanced country reaped the benefits.
  • This discontent in few segments have led to backlash against trade.
  • The investment demand slide too is limiting the global trade opportunities.
  • Taking the export led growth path is challenging for India due to the global environment, though that’s not the sole reason for its poor export performance.
  • Despite adverse environment, Bangladesh, Vietnam and China’s share in global exports are rising while India’s share in global exports is falling.
  • Even though China’s export share in its own GDP is slipping, it still looms large because its share in global exports continues to rise.
  • The report said, “As China moves up the ladder of sophistication in manufacturing, it is slowly vacating space in low-end manufacturing”.
  • Indian economy could benefit from capturing this low end segment since it has the potential for providing employment to the low-skilled workforce.
  • However, India seems to be lagging behind Vietnam and Bangladesh in the race to capture this space.”
  • It is hard for Indian manufacturing firms to be competitive when constraints such as inadequate physical infrastructure (reliable power, water), inflexible labour laws, an opaque land acquisition system and logistical bottlenecks are present.

Suggestions:

  • Strive to improve competitiveness rather than follow protectionist policies, given that India is well-integrated with the global economy.
  • India should focus more on domestic demand led growth considering its large market size and subdued global demand condition impacting it more than the Asian peers.
  • India must walk both the roads (Export led & Domestic demand led growth) simultaneously to achieve the full potential of Make in India program.

Indian scenario:

  • Some of the positives are in the form of improved global competitiveness, as indicated by India’s rankings in the World Economic Forum’s Global Competitiveness Index, World Bank’s Ease of Doing Business and Logistics Performance indices, and Transparency International’s Corruption Index.
  • India remains the third largest economy in Purchasing Power Parity (PPP) terms and it is also currently the fastest growing large economy with a large domestic market.
  • Empirical evidence suggests that when economy is in the middle income phase, demand for manufactured goods accelerates with every unit increase in income. For India, which has recently entered the middle income segment and is the fastest growing large economy, this implies that its domestic market is at the cusp of an expenditure boom. 

Way forward:

  • The report emphasized that to realize the potential of the domestic market for India’s manufacturing sector, the government should focus on improving purchasing power across all sections.
  • Unlike exports which are primarily determined exogenously through external demand, components on domestic demand are dependent on domestic income.
  • Policy measures that ensure distribution of income growth to all sections will sustain domestic demand-led growth.
  • This can be achieved by subsidizing the poor but more by empowering them to participate in the growth process.
  • Measures such as financial inclusion, education, fair property rights, and price stability can serve as catalyst in ensuring equitable growth.
[Ref: Economic Times]

 

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