Wednesday, September 10, 2014

India - Economic Survey for 2013-2014 - Chap 1

Chapter 1 State of the Indian Economy

Excerpts and Summary

The growth slowdown in the last two years was broad based, affecting in particular the industry sector. Inflation too declined during this period, but continued to be above the comfort zone, owing primarily to the elevated level of food inflation. Yet, the developments on the macro stabilization front, particularly the dramatic improvement in the external economic situation with the current account def icit (CAD) declining to manageable levels after two years of worryingly high levels was the redeeming feature of 2013-14.

The f iscal def icit of the Centre as a proportion of GDP also declined for the second year in a row as per the announced medium term policy stance. Reflecting the above and the expectations of a change for the better, f inancial markets have surged. Moderation in inflation would help ease the monetary policy stance and revive the conf idence of investors, and with the global economy expected to recover moderately, particularly on account of performance in some advanced economies, the economy can look forward to better growth prospects in 2014-15 and beyond.

The Indian economy has been going through challenging times that
culminated in lower than 5 per cent growth of GDP at factor cost
at constant prices for two consecutive years, i.e. 2012-13 and 2013-
14. Sub-5 per cent GDP growth for two years in succession was last
witnessed a quarter of a century ago in 1986-87 and 1987-88 (Figure
1.1). Persistent uncertainty in the global outlook, caused by the
crisis in the Euro area and general slowdown in the global
economy, compounded by domestic structural constraints and
inflationary pressures, resulted in a protracted slowdown. The
slowdown is broadly in sync with trends in other emerging
economies, but relatively deeper. India’s growth declined from an
average of 8.3 per cent per annum during 2004-05 to
2011-12 to an average of 4.6 per cent in 2012-13 and 2013-14. Average
growth in the emerging markets and developing economies
including China declined from 6.8 per cent to 4.9 per cent in this
period (calendar-year basis). What is particularly worrisome is the
slowdown in manufacturing growth that averaged 0.2 per cent per
annum in 2012-13 and 2013-14.

Although average wholesale
price index (WPI) inflation declined in 2013-14 to 6.0 per cent vis-
à-vis 8.9 per cent in 2011-12 and 7.4 per cent in 2012-13, it is still
above comfort levels. Moreover, WPI inflation in food articles
that averaged 12.2 per cent annually in the five years ending
2013-14, was signif icantly higher than non-food inflation.

The external sector witnessed a remarkable turnaround after
the first quarter of 2013-14, and the year ended with a CAD of 1.7
per cent of GDP as against 4.7 per cent in 2012-13. After plummeting
to ` 68.36 to a US dollar on 28 August 2013, triggered by the
expected taper of quantitative easing in the United States, the
rupee gradually strengthened and the year ended with the exchange
rate averaging ` 61 per US dollar in March 2014, owing to measures
taken by the government and the Reserve Bank of India (RBI).
Foreign exchange reserves increased by nearly US$ 40 billion from
US$ 275 billion in early September 2013 to US$ 314.9 billion on
20 June 2014.

Improvement is also observed on the fiscal front, with the fiscal deficit declining from 5.7 per cent of GDP in 2011-12 to 4.9 per cent in 2012-13 and 4.5 per cent in 2013-14. Much of this improvement has been
achieved by reduction in expenditure


Box 1.1 : What are structural constraints?
The impact of domestic structural factors on the current economic slowdown in India is often explained in terms
of the irreconcilability of rate of fixed investment of around 30 per cent of GDP and sub-5 per cent growth, given
India’s demand conditions and long-term incremental capital-output ratio. Application of time series techniques
that attempt to decompose the slowdown into structural and cyclical components, have acknowledged the presence
of both, though the assignment of proportions differs (Chinoy and Aziz [2013]; IMF, WEO [2014]; Mishra [2013],
among others). The accentuation of structural constraints has been one of the factors contributing to sub-5 per
cent growth without a commensurate large decline in investment rate.
What are these structural factors? Salient among them as indicated by some studies are the following:
 Difficulties in taking quick decisions on project proposals have affected the ease of doing business. This has
resulted in considerable project delays and insufficient complementary investments.
 Ill-targeted subsidies cramp the fiscal space for public investment and distort allocation of resources.
 Low manufacturing base, especially of capital goods, and low value addition in manufacturing. Manufacturing
growth and exports could be facilitated with simplified procedures, easy credit, and reduced transaction cost.
 Presence of a large informal sector and inadequate labour absorption in the formal sector. Absence of required
skills is considered an important reason.
 Sustaining high economic growth is diff icult without robust agricultural growth. Low agricultural productivity
is hampering this.
 Structural factors engendering continued high food inflation need to be tackled. Issues related to significant
presence of intermediaries in the different tiers of marketing, shortage of storage and processing infrastructure,
inter-state movement of agricultural produce, etc. need to be addressed.
1. Chinoy, Sajjid Z. and Jahangir Aziz (2013), ‘Why is India’s growth at a 10-year low?’, available at
2. Mishra, Prachi (2013), ‘Has India’s Growth Story Withered?’, Economic and Political Weekly, vol. XLVIII (15).
3. International Monetary Fund (IMF) (2014), World Economic Outlook (WEO), April.

The last two years were particularly disappointing for the
manufacturing sector, with growth averaging 0.2 per cent per
annum. The decline has been quite broad based, as per data from
the index of industrial production (IIP). Decline in the growth
rate for basic goods continued for the third year in succession in
2013-14. Output of capital goods declined for the third year in a
row starting 2011-12. Contraction of 12.2 per cent in the consumer
durables segment was observed in 2013-14. Only intermediate and
non-durable consumer goods registered higher growth rate in 2013-
14 vis-à-vis 2012-13. Following close to double-digit growth between
2004-05 and 2011-12, the construction sector (that was the major
source of employment in this period, as can be seen from Box 1.2)
lost momentum in the last two years. Taken together with the
trends in capital goods, the slowdown in construction activity
reflects subdued business sentiments.

Box 1.4 : Investment Slowdown : Proximate Factors
Is it the nominal or real interest rate that explains the reduction in investment rate? A study entitled ‘Real Interest
Rate Impact on Investment and Growth- What the Empirical Evidence for India Suggests?’, by the RBI, indicates
that it is not so much the nominal but real interest rate that explains investment decisions. It is, however, argued by
some that, in recent years, investment growth has weakened despite lower real interest rates. The study highlights
that a lower real interest rate can stimulate investment and growth, provided it is not achieved via higher inflation.
The study further suggests that nominal interest rate is, however, more important than real interest rate for
investment planning at the f irm level.
The RBI study also points to the role of leverage in explaining investment decisions: ‘In a highly leveraged sector,
such as infrastructure, the required rate of return on equity may remain high but the actual return on equity will
be a function of interest costs and cash flows outlook. If interest costs rise and expected cash flow declines,
arranging adequate equity capital flow could be diff icult, which in turn may lead to shelving of some of planned
investment projects.’ The decline in cash flows of corporates could also be attributed to (a) sluggish demand
conditions, (b) weak pricing power, (c) high input cost, and (d) delays in collection of receivables after delivery of
Part of the slowdown in investment growth post 2007-08 can be attributed to policy uncertainty emanating from
diff iculties in land acquisition, delayed environmental clearances, infrastructure bottlenecks, problems in coal
linkages, ban on mining in selected areas, etc. According to Tokuoka (2012), high and volatile inflation (partly
caused by high fiscal deficit) along with heightened global uncertainty may have resulted in slowdown in corporate
investment. Slowdown in investment could also be explained in terms of the subdued business environment and
bleak business confidence.
Anand and Tulin (2014) suggest that while real interest rates explain aggregate investment activity better than
nominal interest rates, they account for only one quarter of the explained investment downturn. They conclude
that standard macro-financial variables do not fully explain the recent investment slump and increased uncertainty
along with deteriorating business conf idence have also played a key role. According to them, lowering nominal
interest rates may provide short-term relief from interest burden but, in the medium term, lower rates with little
slack in the economy will lead to further inflation, affecting investment adversely. Therefore structural reforms and
resolving supply-side bottlenecks are the key to incentivizing investment.
1. RBI (2013), ‘Real Interest Rate Impact on Investment and Growth — What the Empirical Evidence for India
Suggests?’ available at
2. Tokuoka, Kiichi (2012), ‘Does the Business Environment Affect Corporate Investment in India?’, IMF Working
Paper, WP/12/70.
3. Anand, Rahul and V. Tulin (2014), ‘Disentangling India’s Investment Slowdown’, IMF Working Paper, WP/14/47

Prospects for 2014-15

the Indian economy can recover only gradually with
the GDP at factor cost at constant prices expected to grow in the
range of 5.4 – 5.9 per cent in 2014-15. This assumes the revival of
growth in the industrial sector witnessed in April 2014 to continue
for the rest of the year, the generally benign outlook on oil prices
(notwithstanding the uncertainty on account of recent
developments in the Middle East), and the absence of pronounced
destabilizing shocks (including below-normal monsoons). Growth
in the above range implies a pick-up, aided by an improved external
economic situation characterized by a stable current account and
steady capital inflows, improved fiscal situation and, on the supply
side, robust electricity generation and some recovery in
manufacturing and non-government services.

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