Our investment rate is down, our savings rate is low, and it remains hard to do business in India. Tough times lie ahead.
If any economy has to grow, it must invest.
India’s investment rate peaked at 38% of GDP in 2007-08, and GDP growth rate – measured by the old series – racked up 9.4%. In 2016-17, our investment ratio was down to 26.7%. With that huge reduction in capital formation, it would be unrealistic to expect the economy to return to anything like 8% growth, even under the new series.
Of course, it matters where and how well you invest that money. For example, a rupee invested in a power plant will add a much smaller amount to annual production than a rupee invested in a tea shop. Economists measure this return by the ICOR, or Incremental Capital Output Ratio — how much capital is required per unit of extra output. The power sector has an ICOR of 15 to 18, while hotels and restaurants come in somewhere between 1 and 2. And I guess pakoda stalls are even more efficient at converting capital to income.
Whether electricity, mining, or heavy manufacturing, building out infrastructure and industry calls for huge amounts of capital. China mobilised huge amounts of saving to fund its meteoric rise. In 2007, the nation saved a staggering 53% of its GDP — almost twice our current rate. With this kind of saving, it could grow at over 10% per annum, even while building out infrastructure at an unprecedented rate. India’s growth has been much more dependent on services, which require considerably less capital. Our ICOR is estimated at about 4, while China’s has been rising, and is currently about 6.
At a savings rate of 27 to 28 per cent, India cannot expect to grow at much more than 7% p.a., other things remaining equal. “Other things” for poor nations like ours usually means investment funded from abroad, whether by loans or direct investment. Since 2008, the world has been awash with liquidity — much of it created by the US Federal Reserve, in response to the financial crisis of that year. India, along with many other ‘emerging nations’, has been a beneficiary of that liquidity.
America used these ten years of cheap money to clean up its banks, build new businesses and create new jobs. We still don’t know the extent of our bad loans, doomed public enterprises like Air India are guzzling cash, and road projects remain incomplete for decades..
American authorities are shutting the window on cheap money — its stock markets are at all-time highs; and when Amazon raised its minimum wage to twice the US government standard, this signalled how tight the labour market is. Consequently, ‘yields’, or the return on bonds, have also spiked.
What this means is that borrowing for growth will become more expensive. Meanwhile, China’s savings rate has come down to 45%. When the world’s largest saver spends more, global savings are deeply impacted. India will have to compete much harder for investment funds.
India is not the easiest place in the world to do business in. Even with our improved ranking of 100, we are characterised by a great deal more squeeze than ease. The last four years have been full of turmoil for Indian business – first the shambolic demonetisation; then the move to GST, which is only now settling down. The size of our economy is attractive, but foreign companies know how hard it is to build businesses here.
In contrast, portfolio investors have been keen to invest here, as our bonds offered much higher yields, and our shares were priced up to reflect much higher growth than in the west. Those dynamics are rapidly changing — US economic growth is accelerating, while ours is slowing. Meanwhile, rising oil prices and sluggish exports have put pressure on the rupee. This makes investors fear more losses; they exit, putting more pressure on the rupee, etc. This outflow of funds also drives up the interest rate.
This cycle can be quite vicious, as we are currently experiencing. I don’t want to sound too morose, but this can feed into more unfinished projects, which become unviable in the face of rising interest costs. Of course, this means that capital has been spent, but little income is generated.
To quote Dr Rangarajan, ex Governor of the RBI: “Once the growth rate starts to decline, it sets in motion a vicious cycle of decline in investment and lower growth.”
Unless something dramatic happens on the world stage, we’re in for a long period of hugely lowered growth. And of course we can blame Nehru for it.