An L-shaped recovery
Not only has industrial growth collapsed, the services sector's ability to grow independently is also in serious question. Services continues to be the fastest growing sector, but 6.6 per cent growth in the first quarter is a pale shadow of the near-10 per cent annual growth in the last decade. Consequently, unlike the V-shaped recovery that we saw after the Lehman crisis, the economy is not even showing signs of a U-shaped recovery. The trough has only got longer and a painful L-shaped trajectory for growth is visible for the rest of 2013-14.
To me, the most disappointing trend in GDP over the last couple of quarters has been the dismal performance of industry and, in particular, the slump in the manufacturing sector. The industrial sector registered a two decade-low growth of 2.1 per cent in 2012-13. The momentum has weakened further with a meagre growth of 0.2 per cent in the first quarter 2013-14.The manufacturing sector fared even worse. In April-June quarter this year, manufacturing GDP contracted by 1.2 per cent and that, too, on a weak base of -1.0 per cent growth during the same period last year.
What ails manufacturing?
The genesis of the sharp slowdown in manufacturing can be traced to 2011-12, when manufacturing growth dropped to 2.7 per cent from nearly 9 per cent in the previous year. The slowdown in manufacturing is very closely related to the deterioration in the private investment climate since manufacturing activity in India is essentially private sector-driven. In 2011-12, the private sector contributed 92 per cent to GDP as well as investment in the manufacturing sector. The manufacturing sector is also investment-intensive - its share in GDP is 15 per cent but its share in India's total investments is almost twice that.
Private sector investment in manufacturing fell by 9.3 per cent in 2011-12. Delays in implementation of ongoing projects due to policy-related issues and fewer project announcements suggest that the situation has only worsened since then. Further, this sector is closely related to mining and minerals, which has continued to shrink since 2011-12. And now, with anaemic private consumption demand, manufacturing is bound to suffer even more. The pain is already visible in automobiles and other durable goods and is expected to continue through 2013-14.
Fewer jobs and weak services
Together with the collapse of manufacturing sector growth, its ability to absorb labour, too, has been eroding over the past few years. This has adverse implications for job creation in a country where over 12 million youth enter the job market each year. The recently released National Sample Survey results confirm that manufacturing sector employment increased by only 4.4 million between 2004-05 and 2011-12, when the economy expanded at a historically high annual growth rate of over 8 per cent. Crisil estimated that to produce output worth Rs 10 lakh (in real terms) the manufacturing sector was only using around seven workers in 2011-12, compared with 12 workers in 2004-05. One reason for this is firms' proclivity to substitute labour by capital due to rigid rules for hiring and firing employees in India. With anaemic growth in manufacturing and cost-cutting pressures, even fewer jobs will be created.
Earlier, India's large population was treated as a liability due to the challenge of feeding and providing them basic services such as health and education. However, in the last decade, India's large youth-dominated population (50 per cent of India's population is below 25 years) began to be viewed as an asset due to high GDP growth. Favouring this perception was also the fact that the population was ageing in the affluent West and also in not so-affluent China (engineered through the one-child policy). Against this backdrop, India's large supply of youth began to be treated as a major contributory factor to India's brightening prospects. India was being perceived as the work horse for the world. This view is now changing fast. If the manufacturing sector does not revive and become the engine of growth, India's perceived demographic dividend (its youth) will be squandered.
The sharp slowdown in services sector growth is also a grim reminder that when the industry is not doing well, services, too, cannot independently surge ahead. The linkages between industry and services have strengthened over time; industry/manufacturing is extending its weak performance to the services sector as well. Input-output data suggests that producing one unit of industrial output required 0.44 units of services in 2007-08 versus 0.36 units in 1988-89.
If the slowdown in manufacturing continues for a protracted period, creating jobs will become an insurmountable task and the prospect of a demographic dividend will transform into a reality of demographic liability. And services, too, will lose its sheen.
The author is chief economist, Crisil