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How to bring back the growth years?

 

 


Context


The growth in India has dipped from its peak of 9.4% in the year 2007-08 to ~7% in 2016-17 with a couple of years in between even clocking subpar ~5% growth. We need a constant growth rate of 9%+ for a decade or more to solve the problem of poverty and escape the middle-income group trap.

The below is the analysis of how we could do it based on the article written by C. Rangarajan, the former RBI Governor of India.


Bottlenecks in the growth


The growth rate is determined by two factors –

  • Investment rate and
  • The efficiency of the capital.

Harrod-Domar Model gives an equation which puts growth rate as the Investment rate divided by the Incremental Capital Output ratio.

GDP rate= INVESTMENT RATE / ICOR.


ICOR


The ICOR is the amount of capital required to produce one unit of the output. Higher is the ICOR, the less the efficiency of the use of capital. Thereby lower growth.

  • If the Indian growth performance has been weak in the last 5 years, it is because the investment rate has declined and the ICOR has increased.
  • ICOR captures a variety of factors like technology, the skill of manpower, managerial competence, macroeconomic policies, stalling of projects, non-availability of critical inputs etc. All of these increase the cost of capital and thereby lowering the efficiency of capital and higher ICOR.

Investment Rate


Investment rate reached the peak in 2007-08 to 38% with an ICOR of 4 and it’s not surprising we achieved the growth rate of 9.4%. In 2016-17 the investment rate was only 26.9%, with this investment rate it is impossible to achieve 8-9% growth.


Structural Bottlenecks


The structural bottlenecks remain a barrier to achieve a higher growth. This includes delays in project approval, ill-targeted subsidies, low manufacturing base and low agricultural productivity, difficulty in land acquisition, weak transportation network and power supply, and strict labour regulations and skill mismatches

 

Why Investment rates fell post 2011-2012?

  • One of the reasons given in “policy paralysis” because of the demands of the “coalition politics” and the government got involved in the cases of corruption.
  • But that doesn’t explain the steady fall of investment even after 2014 when we elected a government with an absolute majority and no graft charges are crippling the government.
  • The other reasons are the external environment which is not encouraging, growth rates of Advanced Economies didn’t pick-up after 2008 crisis which has had the impact on our imports and exports and lowered the incoming FDI a bit.
  • High level of Inflation post-2011 also had an adverse impact on investment sentiment. Once the growth rates start to decline, it sets a vicious cycle of low investment and low growth.

Solutions to the situation


Solve the issues of investment

  • When Private investment is when the private investment is weak, public investment should be raised with a long term view. Central government capital expenditure has been only 1.8% of GDP and about 3-4% from PSUs.
  • PSUs should make explicit statements with plans and intentions about the extent of investment they intend to make in the given fiscal year, short term and medium term which should be monitored every quarter. This will incentivise the PSUs streamline their investments and also inspire the confidence in private companies and investors.
  • There have to be incentives given to the corporate sector to raise investment it has been 14% of GDP in 2007-08 since then it has continually fallen. Cutting down on retrospective taxation and bring corporate taxes on par with manufacturing competitive countries soon will help them invest more.

Moving the Stalled Projects

  • Simplification of Procedures, cutting down on red-tape more proactively, speeding up of the delivery system, enlarge competition are important. In this regard, the GST, Bankruptcy Act and widening of the scope of FDI are good steps. Next up reforms would be to bring FDI in Multi-brand Retail and increasing the disinvestment of sick companies.
  • The stalled projects should be brought to completion. For the short-term rise in growth, the stalled projects should get moving. Some of them may be unviable now, but a periodic reporting and review of the stalled projects by the government would help.

Tackling Financial Bottlenecks

  • Financial Bottlenecks need to be cleared, of which the biggest is the NPA problem which affects the profitability of the banks and their ability to lend. The NPAs need some haircuts, but alongside punishing the wilful defaulters have to be punished.
  • The idea of the long-term lending which was used by the IDBI and ICICI before 1998 should be reconsidered by working out on the terms.
  • Some other banking sector reforms are discussed here.

 


Conclusion


The investment is an act of faith in the future by the investors. There is absolute necessity to create a climate which promotes this faith. These are also influenced by polity and society. Avoidance of divisive issues is important in this context.

Development should be the only agenda of the government and it is the need of the hour.

A sustainable and stable policy environment for foreign merchandise and services trade; linking rules, procedures and incentives for trade with other recent initiatives such as “Make in India”, “Digital India” and “Skills India”; promoting the diversification of India’s exports by assisting key sectors to become more competitive; and creating an architecture for India’s engagement with key regions of the world will take us a long way.

 


Practice Questions
  1. Investment rate in India has continuously fallen since reaching peak in 2007-08. Enumerate the reasons and suggest ways to increase investment.

 


Additional Reading: A report by the Observer Research Foundation has discussed an agenda of next round of reforms suggested for India. You can go through if you have time. Not absolutely necessary, though. It can be accessed here


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