Despite investments, no significant pick up in GDP

This is due to mismatch in capital creation and stuck up projects

India's economy grew by sub-5% for the fourth quarter in a row during July-September, 2013-14, even as the gross fixed capital formation (GFCF) rate, a proxy for  investment, hovered around 30% of gross  domestic product (GDP). This much  GFCF rate is enough to yield growth rate of over 7%.  It is interesting to note that despite high interest rates and low demand, GFCF is holding on to around 30% over the years.

In the second quarter of the current  financial year, GDP precisely rose 4.8% when GFCF stood at 29.4% of GDP. Such a dismal growth on not so much low GFCF is basically due to rising incremental capital output ratio. This in simple terms means that a given amount of capital invested is not yielding the desired output.

Had capital output ratio been four, 29.4% of GFCF would have produced GDP growth of 7.3%. However, ICOR rose to 6.1 in the second quarter of 2-13=14 from 3.2 in 2006-07. During 2006-07, GFCF at 31.3% of GDP had produced economic growth rate of 9.6%. This means that while GFCF rate declined 1.9 percentage points, economic growth rate halved between 2006-07 and the second quarter of 2013-14.

ICOR has been rising due to inefficiency in the economy due to which various projects are either stuck up or there is imbalance between various investments.

"It is because of imbalance in capital creation. One example is power and coal imbalances. Capital efficiency is going down," Subir Gokarn, director of research, Brookings India, and former deputy governor of the Reserve Bank of India, told Business Standard.

According to a study by consultancy  firm  KPMG, delays in implementing power projects, mainly caused by fuel issues, could turn Rs 1 lakh crore of bank loans into NPAs if prompt action is not taken.

"Lack of financing and a poor pipeline is due to the current stalemate on various projects. Over 33 GW of projects are operating below 60% plant load factor, mainly due to fuel issues. This could pose a risk to over Rs 1 lakh crore worth bank loans which could turn into NPAs if we don't take action quickly," KPMG said.

	GDP Growth Rate	Gross Fixed Capital Formation As % of GDP
2005-06	9.50%	30.30%
2006-07	9.60%	31.30%
2007-08	9.30%	32.90%
2008-09	6.70%	32.30%
2009-10	8.60%	31.70%
2010-11	9.30%	31.70%
2011-12	6.20%	30.60%
2012-13	5%	29.60%
Q1,  2013-4	4.40%	28.60%
Q2,  2013-14	4.80%	29.40%
Source: Central Statistics Office, Prime Minister's Economic Advisory Council

Shankar Acharya, honorary professor at ICRIER and former chief economic adviser, said lot of projects are lying idle because of which investment rate is rising but desired output is not coming. This is due to overall inefficiency in the economy and policy inaction, he said.

Citing an example, he said Vendanta has invested in aluminium project in Odisha but bauxite raw materials are not forthcoming due to tribal issues.

Recently, Anil Agarwal, who controls London-based Vedanta Resources Plc, said he regrets investing $8 billion on an aluminium complex in India that’s faced a shortage of raw materials.

“I could either invest in Vedanta Aluminium or I could have bought Asarco,” Agarwal said in an interview with Bloomberg TV.

Complex government procedures are delaying project approvals in India and impeding companies, Agarwal had said.

Vedanta Aluminium is running below capacity after failing to get approval from local tribes to mine bauxite.

Precisely to clear the stuck up projects, the Cabinet Committee on Investments (CCI) was set up earlier this year. It has so far cleared projects, costing over Rs 3 lakh crore.

Will these lower ICOR and result in desired growth rate?

To this query, Gokarn said it depends on what kind of projects CCI is clearing. The issue depends on whether CCI is clearing the projects that are causing bottlenecks and whether these are being implemented after getting cleared by CCI.

CCI has so far cleared projects relating to  power, oil, road and other infrastructure sector.

Acharya said it would be worthwhile to see on the ground that what is happening to these projects.

Meanwhile, scores of highway projects including those developed by GMR, GVK and Ashoka Buildcon are facing delays on account of high premium. The Cabinet had earlier approved a proposal for postponement of premium payments by highway developers.

Premium is a payment made by the developer to the National Highway Authority of India in build, operate and transfer projects. The premium, which is offered by companies during the bidding stage, is based on projected returns from tolls.    

On a bit  longer period, GDP growth for 2011-12, 2012-13 and in the first half of 2013-14 has been 6.2%, 5% and 4.6% respectively. Even if one takes the average for this period, and not the latest quarter, a growth of 5.8% over two-and-a-half years is the same as it used to be in the 1980s and 1990s. However, in those decades GFCF used to be much lower--less than 25% of GDP.

Does it mean  that we are back  to those days in terms of efficiency in the economy?

Gokarn said it  is not  right  to compare the two periods as the economic situations were completely different then  and now. However, the moot issue is that the economy has a potential to grow 8%  but it is expanding below 5%, he said.