The incremental capital output ratio declined in 1996-97. This is big news (on the assumption that a decline in a single year is indicative of a trend). In 1996-97, with an aggregate investment of 27.4 per cent of GDP, the Indian economy churned out a growth rate of 7.5 per cent, the peak rate under reform. This gives an Icor (investment divided by growth) of 3.65 against the previous 4.Economists like Isher Judge Ahluwalia and Shanker Acharya (of the finance ministry) are reportedly raving about how, under reform, the economy is getting more output per unit of capital. In 1996-97, domestic savings were 26.1 per cent of GDP; this could be nudged up to 26.5 per cent. With the current account deficit (foreign savings) pitched at a safe level of 2.5 per cent of GDP, aggregate investment could be boosted to 29 per cent.
Now comes the exciting prospect held out by the Icor decline of 1996-97. With this Icor, the annual GDP growth could be taken to 7.94 per cent. This is a tiger rate. Raising the savings rateto tiger proportions (30 per cent plus) will not be necessary (A high savings rate in a poor country necessarily requires incomes of the rich to grow fast. India need not push for increased income inequality). This is topping.
A decline in the Icor is to be devoutly wished for. The trouble is that the Icor can slip for reasons other than an improvement in the efficient use of capital. That is why, a single year's low Icor is nothing to go by. It is the average Icor over a period that is significant.
Icor is an expression of value; it measures how much investment in rupees yields how much output in rupees. Now suppose prices of capital goods have fallen, but not prices of output. Icor may then decline without a gain in real output. But the price relationships may change in a subsequent year and raise the Icor.
Note that import duty on capital goods is now down to 10 per cent. Consequently, domestic capital goods prices have been held in check.
Over-all, the evidence is that prices of capital goods inIndia have risen less than has the general price level.
It is difficult to say what the Icor decline of 1996-97 was due to. Sure enough, take evidence of new investment as given. But did new investment give new output, or is it that capacity utilisation in the economy improved? Output could have spurted because of improved capacity utilisation. This could exaggerate output growth relative to investment growth.
But take the decline in Icor at face value. Will the improvement be sustained? The issue is the type of investment taking place. If investment in long gestation projects is being avoided (light industry is preferred to heavy industry and rerolling mills to integrated steel plants, for example), as seems likely, Icor will decline.
There is evidence that backward integration is being bypassed. This results in a quick gain in output from investment. Favoured naphtha-based power projects yield power quickly, besides requiring less investment relative to coal-based power projects. (The latter requireinvestment in domestic coal mines, washeries and above all railways). Naphtha - power is a low Icor investment.
But low backward integration means larger imports. Naphtha will have to be imported. If exports do not rise commensurately, it could mean trouble ahead. By analogy, tubewells give results in the short run; irrigation projects take a long time to deliver. But tubewells can suck up the ground water level to the point of disaster. The parallel with respect to low backward integration is increasing import dependence. To absorb this, the country must increase exports in an abiding fashion. There is no evidence of this.
A declining Icor by itself may not be cause for jubilation. To celebrate the decline of 1996-97, it will be necessary to know what brought it about. Actually, it may be that the Icor was even lower than has been estimated for 1996-97. Financial savings rose that year, but investment neither in the corporate sector nor in the public sector was vigorous.
The counterpart of the rise infinancial savings is a decline in savings in physical assets. This suggests that there was a decline in investment by unregistered enterprises (where did investment go?) So, was aggregate investment as large as estimated, or was it smaller? If the latter is the case, given the GDP growth estimate, the Icor was even lower than has been reckoned! The short point is that a single year's Icor is far from definitive. In any case, for tigerisation what is germane is the export growth rate and not a statistical decline in Icor.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
