The recent growth scenario of India has been quite remarkable, with the economy registering 9% growth rate for the last 4-5 years. In order to ensure a higher growth rate of the economy, the Investment-GDP ratio must increase. In India, the investment-GDP ratio showed a marked increase over the last few years, starting from 2001-02.
Now, the question is what has led to this massive increase in the investment-GDP ratio. In other words, which components of investment have increased dramatically during this period leading to such a huge increase in the investment rate? This has been largely due to the performance of the corporate sector of the country. Over a long period of time, it had been the case that households’ investment has been the major source of capital formation in the Indian economy. However, in the recent past, the investment by the private corporate sector has increased more than that of the household sector. In other words, the recent increase in the investment rate and the growth rate of GDP has been led largely by the private corporate sector.
In this context of a private corporate sector driven growth in the Indian economy, it is obvious that the performance of the private corporate sector is of crucial importance to maintain the high growth trajectory in India. It is in this regard that the performance of the Indian corporate sector in the last quarter is a cause of worry.
In a study conducted by the Economic Times it has been found that India Inc.’s profit growth has witnessed a sharp slow down in the second quarter of the current financial year. It is found that out of 1,450 listed firms (excluding banks and oil & gas majors), aggregate net profit growth has come down to 5.7%, which was 25.8% in Q2 of 2007-08 and 9.9% during the first quarter of 2008-09. 20% of the companies in the sample have reported net loss as against 14% during the second quarter of 2007-08. (Source: India Inc.’s Profit Drive Takes a Beating, The Economic Times, 3 November 2008).
In another separate study undertaken by the Business Line it has been found that 116 companies out of a sample of 814 companies have seen a decline in the ‘value added’ (measured as the sum of ‘net sales’, ‘other incomes’ and net addition to inventory minus the value of raw material and stores consumption) during June and September 2008 quarters compared to their immediate previous quarters. (Source: It is Recession for One in Seven of NSE Listed Companies, Business Line, 3 November 2008).
The question that immediately arises out of this is what accounts for the decline in the profit for these companies. We know that profit is the difference between total revenue and total cost. Therefore, a decline in profit must mean a decline in the total revenue of the firm or an increase in the cost of the firm. As regards revenue, it has been found that at the aggregate level, growth rate of net sales of the companies in the sample was 28.3% during the latest quarter as against 17.7% for the same period last year. (Source: The Economic Times, 3 November 2008).
Thus, the decline in profit has to be accounted for by an increase in cost. The biggest component of the increased cost has been the increase in the interest rate. It is estimated that interest costs rose by 72% in the last quarter as against 26% during the same period last year. Added to this, there has been an increase in raw material prices for manufacturing industries, which has also pulled down profits. (Source: The Economic Times, 3 November 2008).
The question is what accounts for the increase in the interest rates as well as raw material prices for the industries. There are several reasons for this. Firstly, the rise in the interest rate is due to two basic factors. (a) In order to tame the rising inflation in India, the RBI announced hikes in the Cash Reserve Ratio as well as the repo rate in August 2008. In response to this tight monetary move of the RBI, the banks also hiked their interest rates on loans. (b) With the global credit crisis looming large in the horizon, the Indian corporate sector could not find loans in the international market also.
Secondly, the hikes in the raw material prices are mainly due to the hikes in the prices of oil, agricultural products, particularly food grains and steel at a global level. Most importantly, oil is a commodity which is almost universally used by all industries. Therefore, a hike in the price of oil is bound to increase the raw material prices in a big manner. (It is however the case that the prices of oil in the international market has decreased. But this has not been translated into a decrease in the domestic price of oil because of the high tax burden that the Government continues to impose on the people.) However, it must be remembered that this hike in the raw material prices that we are talking about is really not an Indian phenomenon but largely due to global economic problems. But with policies of globalization indiscriminately followed in India, it is but natural that all these problems have crept into the Indian economy resulting in problems for the common people as well as the corporate houses of the country.
Now, with the rise in the prices of raw material and higher interest rates, resulting in higher costs, the prices of end products of the companies also increased. This is mainly responsible for the increase in the revenue of the firms. “For instance, the country’s largest automaker, Maruti Suzuki, reported a 6% rise in net sales during the quarter even as it witnessed a 2.5% decline in the number of cars sold during the period. Consumer goods firm Hindustan Unilever, which recorded a 22% growth in the Fast Moving Consumer Goods business, attributed almost two-thirds of it to price increases.” (Source: The Economic Times, 3 November 2008). In spite of the fact the companies increased their prices, they could not improve their profit because of the fact that the increase in costs had been even greater.
In addition to this, the latest figures for Index of Industrial Production (IIP) show that the rates of growth of the manufacturing IIP indicate that growth in August 2008 for industry as a whole and manufacturing in particular were 1.3% and 1.1% respectively. This number was 10.86% and 10.75% respectively in the corresponding month of the previous year. This indicates that there has been a slow down in the manufacturing and industrial output growth rates in India. This essentially signifies that there is a serious threat of an industrial recession in India.
This slow down in the growth rate of industrial production is particularly important because of the following. In order for the industrial sector or the economy to grow, there must exist sustained demand in the economy. In India, as has been pointed out by many economists, this demand does not come from the majority of the population. Rather the majority of the population remains impoverished but still the demand exists in the economy because of the consumption of the middle class and the rich. This consumption is essentially fueled by debts undertaken by households from the banks or credit card companies. Now, in the wake of the financial crisis, the norms for such lending have been tightened, with the banks becoming less forthcoming in disbursing these loans. In other words, the avenue for sustained demand through this route has been substantially reduced.
However, in the absence of adequate domestic demand in the economy, the industrial sector might still continue to grow if there is adequate external demand for India’s export commodities. Exports to GDP ratio has increased significantly in the recent past, indicating a better performance of the export sector. However, as a result of the impending recession in the USA, the exports of India has been already adversely affected. For the first time in five years, India’s export growth has turned negative. Exports for October 2008 contracted by 15% on a year-on-year basis. This shows that the external demand route for the Indian corporate sector is also drying out in the wake of the global economic crisis.
The question that naturally arises is how to overcome the problem of slow down in the Indian economy. It has been already seen that both the debt financed consumption as well as the external sector currently is not being able to boost the demand in the economy. This demand boost can however be provided by the Government if it takes upon itself the task of injecting demand into the economy through higher Government expenditure. In the absence of private sector stimulus to growth, the only way out is for the Government to boost demand. However, our policy makers are so entrenched in the ideology of sound finance and neo-liberalism that they are incapable of thinking about this route of advance for the Indian economy.
It is the result of the policies of the Government that the corporate sector rose to the stature of the dominant investor in the economy. This investment while generated high growth could not increase the purchasing power of the majority of the people. With the private sector in a crisis of its own, in the absence of Government boosting demand, the conditions of the people will further worsen. It is time to go back to John Maynard Keyenes and argue like him for state intervention to boost demand.
Author's Note: An earlier version of this article was posted at http://www.realestatetv.in/ResearchDesk/Article.aspx?articleid=1670