For India, the first decade of this century was a watershed in many respects. It started with a below-trend growth rate of 5.5% between 2000-01 and 2003-04, but later surprised on the upside when the economy expanded at a neverbefore-seen rate of nearly 9% per year between 2004-05 and 2007-08. Then the global financial crisis intervened and dragged down growth to 6.7% in 2008-09. But the economy recovered swiftly and forged ahead in the next two years with 8.4% growth.
As the next decade dawned, growth slipped again. GDP growth was at 6.5% in 2011-12 and the prospects are equally weak for 2012-13. The role of the private sector and the public sector in shaping investments and growth during the decade of 2000s is a study in contrast. During 2004-05 to 2007-08, when India?s overall GDP was growing at an average rate of 8.8%, private sector GDP expanded by about 10% compared to 6% in the public sector. During this period, there was also a sharp surge in private investments, particularly from the private corporate sector. Private corporate sector investments grew to 17.3% of GDP in 2007-08 from 10.3% of GDP in 2004-05. This quantum jump in investments was significantly funded by increased savings/retained earnings of the corporate sector, which rose by 2.8% of GDP during the same period. Private corporate sector, thus, played an important role in lifting savings and investments in the economy and, thereby, growth.
The critical role played by the private sector during the boom years from 2004-05 to 2007-08 becomes even more evident when one takes a closer look at manufacturing growth. During this period, private sector manufacturing grew by a remarkable 12.4%, expanding India?s manufacturing sector by 10.5% despite a 0.1% contraction in public sector manufacturing. During 2004-05 to 2007-08, the burden of driving India?s manufacturing growth was borne almost entirely by the private sector, which contributed over 95% of manufacturing investments?a significant rise from 73% in the 1980s. A similar trend was observed yet again in 2010-11, when the manufacturing sector expanded by 7.6% driven by a 10% growth in private sector manufacturing, despite a 12% contraction in the public sector.
The aftermath of the global financial crisis (GFC) changed the growth dynamics as public sector GDP bounced back. The GFC brought down the overall GDP growth to 6.7% in 2008-09 from 9.3% in 2007-08. The 10.2% growth in public sector GDP that year played an important role in cushioning the economy as private sector GDP growth had fallen to 5.8%. Public sector GDP expanded by 12.3% per year during 2008-09 to 2009-10 compared to only 6.2% growth for the private sector.
Private corporate savings and investments dropped sharply during 2008-09 (Table 2). The drop in corporate investments by 26% in 2008-09 over the previous year was much sharper than the fall of 11% in corporate savings in the same period. Clearly, corporates were preserving cash rather than investing. This kind of behaviour of corporates can be attributed to cash preservation that typically happens in a high risk environment.
Had the public sector growth rate not risen (via increased government spending and increase in wages of public sector employees through implementation of the Sixth Pay Commission and other stimuli), overall GDP would have grown at 6.2% per year instead of 7.6% during 2008-09 to 2009-10. With the gradual withdrawal of stimulus in 2010-11 and petering off of the one-time effect of the Sixth Pay Commission, public sector GDP growth fell to 6.5%. GDP growth in public administration and defence had gone up to 19% per year during 2008-09 and 2009-10 from 5.1% in the preceding four years. The real wages (after adjusting for inflation) of Central and state government employees grew at an average rate of 17% per year in these two years. In 2010-11, as the one-time impact of public sector wage hikes wore off, GDP in public administration and defence fell to 1.3% with public sector wage growth at 3.8%. However, private sector GDP growth rebounded to 9.0% during the same year due to improved private demand and some rebound in external demand. Both savings and investments of the private corporate sector went up (as per cent of GDP) in 2010-11 but were much lower than the pre-GFC levels.
What lies ahead? We do not have the GDP data break-up for public and private sectors for 2011-12 but we do know that overall GDP growth fell to 6.5% in 2011-12 from 8.4% in 2010-11. By a reasonable guesstimate, therefore, public sector GDP would have grown at best around the same level as in 2010-11 (6.5%) and private sector growth would have fallen significantly to similar levels of 6.5% from 9.0% growth recorded in 2010-11. What does this mean for 2012-13? Given the tight fiscal position of the government, it means that the ability of the public sector to give impetus to growth by increasing spending is limited. Persistently high inflation implies that the monetary policy via interest rates cuts can play a limited role in revising growth. The depressed global outlook rules out any external stimulus to India?s growth rate.
Under these circumstances, a return to the pre-crisis growth rate of 9% looks like a distant dream. The economy still has the potential to grow at 7.0-7.5% (RBI, 2012), much above the current rate of GDP growth of 6.5%. An improvement in private sector sentiment and pick-up in private sector investment can lift private sector GDP and, hence, the overall GDP growth.
This is particularly important for the revival of manufacturing activity where the private sector plays a dominant role. Overall manufacturing growth collapsed to 2.5% in 2011-12 and was -0.3% in the fourth quarter of the fiscal. Since 90% of the GDP in manufacturing originates in the private sector, a sustainable revival of private sector manufacturing growth will be extremely critical for achieving the ambitious objectives of the New Manufacturing Policy (NMP), which aims to raise the share of manufacturing in India?s GDP to 25% by 2025 from 16% currently.
Policy bottlenecks, slow clearance of projects and rising inflation have dampened private sector sentiments and stifled investments in recent years. These issues need to be urgently addressed to create some upside to the depressed investment outlook for 2012-13. To lay a healthy foundation for higher and sustainable growth over the medium run, these steps will need to be complemented with a fresh dose of reforms to raise the supply potential of the economy.
What will be the public sector?s role? The public sector cannot substitute for the lack of growth in the private sector on a sustained basis. Through increased spending on physical infrastructure (roads, power, etc) and social infrastructure (health and education), the public sector?s role will be to create an enabling environment for the private sector to accelerate investments.
This text is part of a paper presented by Crisil
The authors are chief economist and junior economist, respectively, at Crisil
