There is a strong case for making greater use of monetary instruments at this juncture.
The latest Index of Industrial Production (IIP) shows a steep decline in the growth of industrial production to 3.9 per cent between April and November ‘08 compared to 9.2 per cent during this period in 2007. In October ‘08 there was a decline of 0.4 per cent in the overall industrial activity. This was the first drop in 13 years since data in the current series on IIP became available in April 1995. Under-playing this development and attributing it to shrinking exports is not a complete explanation of an emerging industrial slowdown in India. The fall being witnessed is across manufacturing, and includes several goods with low export intensity.
Manufacturing, with an 80 per cent weightage in IIP, has in recent years been the engine of growth in India. The Index which has grown by an average of 9 per cent in the last four years was often pulled down by slackening electricity generation and mining. But in recent months, cotton yarn, manmade fibres, readymade garment, steel products, aluminum, auto-components, passenger cars, commercial vehicles, cement, paper and petrochemicals — all important manufacturing segments — have experienced considerable demand moderation. In November ‘08, the capital goods output declined for the first time since 2002. Only a gain in consumer non-durables production, arising largely from the still-buoyant rural demand, helped moderate the fall in consumer goods. The output of consumer durables fell by 4.2 per cent in November ‘08 over November ‘07. The overall position in November ‘08 would have been similar to October ‘08 had it not been for the base effect. Provisional data on automobile production, power generation and exports suggest further contraction in December ‘08.
Many factors suggest that the recent slump is not a one-off. There is evident paring of domestic consumption despite the farm debt waiver and the Sixth Pay Commission hikes. The increase in government spending by 8.6 per cent in H1 2008 compared to 3.2 per cent in H1 2007 did not make a material difference to overall consumption since its share in GDP is only 8 per cent. Falling asset prices, rising job losses and sagging confidence are visibly impacting consumption across consumer categories. Prospects of an early revival in overseas demand seem remote with all major trading partners, ie, the US, UK, Europe and Japan in recession.
The investment boom in Indian industry, which between 2002 and 2007 accounted for 10 per cent of the 13 per cent increase in investment-to-GDP ratio, is petering away. Dwindling sales, rising inventories and financial constraints are making firms put their expansion plans on hold. There is an industry estimate of a 30-40 per cent fall in planned industrial investment in 2008-09. The 26/11 terror strikes, which got unprecedented international exposure, have reinforced the slowdown of FDI in industry. Serious questions can now be expected to be raised about corporate governance practices in India in the light of the Satyam episode.
The second stimulus package announced on January 2 was broadly on the lines of the one in December ‘08. While all the measures taken are in the right direction, these have yet to make an impact. Automobile production — particularly of commercial vehicles, whose sales are a conventional lead indicator of an economy and its industrial activity — continues to slip, month after month. Basic goods growth declined to 3 per cent in Q4 2008 compared to almost 9 per cent last year, indicating a possible de-growth in manufacturing activities. Export growth is not picking up despite the improved value of the rupee, extension of the DEPB Scheme and a handful of incentives for textile exports.
Higher allocations for infrastructure do not quickly translate into higher spending especially when the capacity for project development and implementation is limited. The once-active National Highways Authority has not been able to award new road projects for several months. Though IIFCL has been rightly identified for routing long-term funds into infrastructure, its disbursement levels are linked to the implementation rates of borrowers. In any case, most infrastructure spending is not expected to stimulate demand without a time lag of three to four quarters.
Given the limited fiscal room available, efforts have to be targeted to activities with high backward and forward linkages. The heavily stressed segments of Indian industry with such characteristics include commercial vehicles, textiles, leather, gems and jewellery, and construction. Durables, passenger cars, auto-ancillaries, steel products, cement, paper and petroleum products also have high output and employment intensities. The further lowering of CENVAT for passenger cars above 1,500cc engine capacity and trucks and buses needs immediate consideration since these still attract high levies varying between 10 per cent and 20 per cent plus certain ad-valorem rates. Textiles, leather, and gems and jewellery which have high export intensity require additional support to maintain their competitiveness in the global arena. The high MSP for domestic cotton, ab-initio, puts Indian textiles at a disadvantage, and flexible labour laws give distinct advantage to garment and leather-makers in Bangladesh. A 4 per cent import duty on ferro-nickel, needed in India for stainless steel production, puts an extra burden of Rs 2,400 per tonne.
State governments must play a complementary role. They should lower VAT rates on industrial goods produced in large volumes in their jurisdictions even if it means temporarily deviating from uniform all-India rates. Increasing the road tax on vehicles, as done by a few states recently, negates efforts to boost demand and production. To facilitate investment in the current troubled times, the ‘industrial states’ must adopt a more proactive approach, a la Gujarat in the relocation of Tata’s Nano project, unmindful of criticism of helping individual business houses.
There is a strong case for more aggressive monetary policy. Rapidly declining inflation, limited space for fiscal action, and the drying up of overseas funding sources for Indian corporates and their looking homewards for credit, call for making greater use of monetary instruments at this juncture. Making periodic incremental changes in prime lending, repo and reverse repo rates is not yielding the results which cuts in SLR and CRR etc are capable of achieving. The key factor now governing demand is income outlook which has turned negative. To reverse it, monetary authorities must effect sizeable changes in interest rates, and at one go, thereby making for more decisive action on spending rather than deferring expenditure in the expectation of further rate cuts.
The author is a former Industry Secretary to Government of India
