Data for June 2008 has shown that for the first quarter of the current fiscal, IIP growth is at 5.2%, half the 10.3% growth registered in the same period last year. This seems to have raised doubts about industrial performance. In other words, one is interested to know the length and breadth of the current slow growth phase of the sector.
Although the growth slowdown was predicted by us and several other analysts, it is necessary to understand the underlying causes for this slow growth before concluding whether it has bottomed out or not. In the same column in March 2008 I said that the industrial slowdown is here to stay for some time, although many opposed this view at that time.
One of the main reasons for this slowdown is the decline in demand, both external and domestic. A slowdown in the global economy, in particular the US (which is staring at recession), and a rise in the general price level across the globe has resulted in a decline in exports even after the fiscal incentives provided to this sector since last year. Similarly, domestic demand has also declined due to a rise in both inflation to near historic highs and interest rates.
In addition, we have been saying that there could be some business cycles in play. The high industrial growth cycle that started in 2003-04 has been the longest in recent times and any downward movement of the cycle should not be a surprise–and is not expected to be short-lived. On the inputs side, although we don?t see high interest rates as the reason for a slowing down of investment, the rise in fuel prices to historical levels could be a factor for the declining industrial sector, through the increase in the cost of production.
Returning to the issue of the length and breadth of the present slow growth phase, in my view, industrial growth is yet to bottom out. The cyclical nature will ensure that the downward movement is not short lived. Second, we expect the present double-digit inflation rate and its associated high interest rates to continue at least until the end of this year. This would dampen investment. Third, we don?t expect a revival in external demand soon; rather, we expect more sluggishness given the gloomy global economic outlook.
Until recently, based on the robust growth of non-oil imports (assumed to be largely intermediate goods used for final products domestically), RBI argued that the rise in inflation and interest rates has not affected domestic demand and, hence, industry is not expected to enter a recessionary phase. But recent data for non-oil imports in June 2008 shows a decline to 13.8% compared with nearly 25% growth in April-May 2008.
On the other hand, oil imports are growing at more than 50%, which is leading to depreciation and making non-oil imports more costly. Hence, in my view, the slow growth in the industrial sector is only beginning and is expected to last at least a large part of the current fiscal. The decline in capital goods output growth from 23.1% to a meagre 5.6% in the recent period could also corroborate this view.
Two other important factors to be discussed in order to ascertain future industrial growth prospects are investments and the Sixth Pay Commission award. On the investments side, there are some indications that in the recent period, some restrictions have been put on ECBs?a big source of cheap capital for domestic producers?and it seems to have resulted in a significant fall in actual borrowings. This is expected to result in many industries holding their capacity expansion plans and new projects.
The impact of the Sixth Pay Commission on industrial performance is expected to be minimal. One may remember that unlike the Fifth Pay Commission, which nearly doubled wages and had led to upward movement in industrial growth for two years in the late 1990s, the Sixth Pay Commission award is much less. All these factors lead to the conclusion that the industrial growth has not bottomed out and is expected to be prolonged.
?The writer is associate professor, Institute of Economic Growth E-mail: bhanu@iegindia.org