Need better method of measuring capital formation

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Published: September 17, 2019 3:34:18 AM

The major categories identified in NAS series with 2011-12 as base year are dwellings, other buildings and structures (DOBS) and machinery and equipments.

capital formation, steel consumption, indian economy, communication, connectivity, economy newsIn all the advanced countries the use of steel in residential houses and industrial and commercial structures is much higher compared to India.

One of the critical elements that drive steel consumption in the country is investment or capital formation. An investment led economy which is a common feature of a developing economy permits the build up of basic infrastructure (both physical and social) to facilitate communication and connectivity, higher income opportunities, manage inflation and thereby contributing to welfare of its citizens.

In a recent paper in EPW (Vol LIV no 33: Can India raise its GDP per capita….) the author has suggested that the current estimation method of capital formation based on steel price movement has established an erroneous conclusion that while real investment growth (gross capital formation and gross fixed capital formation) is rising, the rate of investment is sliding. The paper has analysed in detail the movement of these macroeconomic parameters along with WPI index of iron and steel prices during 2000-17. Specifically during 2012 and 2017 the investment rate declined, but the growth rate of real investment improved. Thus a better method of measuring capital formation is required. This is an interesting conclusion and draws our attention to the role of steel prices in estimating capital formation and if the method needs a correction to address the avoidance of curious conclusion.

The major categories identified in NAS series with 2011-12 as base year are dwellings, other buildings and structures (DOBS) and machinery and equipments. Most of the DOBS has been rightly identified as pucca construction which has been estimated using the commodity flow approach. As iron and steel has a major share in cost of the basic materials, its movement significantly influences the value of capital formation. It is necessary to point out a few aspects here. First, even in rural areas the current percentage of pucca construction is around 54% and in the urban areas it is more. However, the steel component in the total use of materials is not high. A significant portion of these pucca dwellings and other similar structures are built on Reinforced Cement Concrete (RCC) with steel in the form of rebar is used in the concrete floor. In many cases the concrete flooring can do away with use of rebar and use mere cement layers.

All the load bearing structures in most of these pucca dwellings use bricks, sands and other materials. In fact this provides a good promotional aspect of increasing steel use with cladding and walls made with light gauge steel (hollow sections) in view of rising prices of cement and sands. In all the advanced countries the use of steel in residential houses and industrial and commercial structures is much higher compared to India. While this phenomenon has resulted in frequent maintenance and repair of these dwellings, it has also led to low steel cement ratio in construction sector in India. Against an average 1 to 1.3 in UK, Japan, Korea, the current ratio has reached around 0.382 in India. It would be a good logic to develop a weighted average of prices of iron and steel, cement, sands and other materials in estimating the capital formation corrected for this method of estimation, the windfall gain in GVA in construction would be reduced.

The second issue relates to the use of current data on WPI indices for iron and steel. The author has adopted a composite index of 7 subgroups of manufacture of basic metals as given in the WPI series to arrive at WPI index of Iron and Steel each year. The subgroups include both raw materials and finished products as grouped under: 1) Inputs into steel making (iron ore, DRI, ferro alloys), 2) metallic iron (pig iron), 3) mild steel-semi finished steel (blooms, slabs, pencil ingots), SS Pencil ingots/billets/slabs (item no 601). When the price indices for finished steel (long products, flat products, pipes and tubes, alloy and SS) are given separately, the inclusion of raw materials and semi finished steel prices in constructing the weighted index may lead to double counting as the price indices for finished items are supposed to have already considered the same.

Thirdly, in building up the WPI price index, it is seen from the identification of the items in various subgroups as per WPI series that it include galvanised wire-barbed or not (item no 597), steel cables (598), GI pipes (603), MS seamless steel tubes (605) all of which fall under the category of manufactured items under ITC-HS Code 73. Their inclusion has affected the exclusive indices for iron and steel items. A weighted average of long and flat products and alloy/SS steel [items under (d),(e), (f), (g) and (h)] could be considered to build up the price series for Iron and Steel.

The collection of price data in the WPI series on iron and steel specifically during the years 2011 to 2017 was partially on the basis of listed prices announced by the CPSEs which do not reflect the actual transacted prices or the market prices. The listed prices in general were permitted to be used for quoting in the tender by the user segments. Depending on the market conditions, the transaction prices (net of discounts, rebates) were always lower. As iron and steel prices are one of the major influencing factors for the trend and growth of macro indicators as the above study has succinctly established, the official compilation of data must take care of the market realities.

(The author is DG, Institute of Steel Growth and Development. Views are personal)

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