Industrial Growth in India: Where are we heading?

The latest data for Index of Industrial Production (IIP) has been released for the month of
October 2008. It shows that industrial growth in India has turned negative for the first time since
1993. According to figures of IIP, the overall growth rate of industrial production as measured by
the IIP has been -0.4% in the month of October 2008 as compared with that of October 2007.

The detailed data for the IIP is given in the following table:

Growth Rate of Industrial Production over the corresponding period of the

previous year

Month Mining Manufacturing Electricity General

2008-
2007-08 2008-09 2007-08 2008-09 2007-08 2008-09 2007-08 09

October 5.1 2.8 13.8 -1.2 4.2 4.4 12.2 -0.4

Apr-Oct 4.9 3.7 10.6 4.2 7.2 2.8 9.9 4.1

Source: Press Note -: Quick Estimates of Index of Industrial Production and Use-based Index (Base 1993-
94=100) for the month of October, 2008. Available at: http://pib.nic.in/release/release.asp?relid=45554

From the above table it is seen that the growth rate of the overall index declined from a
high value of 12.2% in October 2007 to a negative -0.4% in October 2008. If we
compare the growth rates of April-October 2007 and that of 2008 we see that the growth
rate declined from 9.9% in 2007 to 4.1% in 2008. In September 2008, this growth rate
was 4.8%. (Source: http://mospi.nic.in/mospi_iip.htm). This massive decline in the
growth rate of the overall industrial index is driven mainly by a drastic fall in the growth
rate of the manufacturing sector.

It is seen from the above table that the growth rate of Manufacturing registered the
maximum fall, whereby it declined from 13.8% in October 2007 to a negative -1.2% in
October 2008. On the other hand, the growth rate of manufacturing declined to 4.1% in
April-October 2008 as compared to 9.9% in the same period in the previous year. The
growth rate of manufacturing in September 2008 was 4.8%. (Source:
http://mospi.nic.in/mospi_iip.htm). Manufacturing sector’s weight in the overall
industrial index is close to 80%. Therefore, it is obvious that such large fall in the growth
rate of the manufacturing sector has resulted in a negative growth rate for the overall
IIP.

As far as mining is concerned, it is seen that the growth rate declined from 5.1% to
2.8%, while there has been a minor increase in the growth rate of electricity production
from 4.2% to 4.4%.

Let us also look into the growth rate of the 6 core infrastructure companies, whose
figures have also been released. This is shown in the following table:
 Index of six core sector industries - October 2008

Weight Oct ’07 Oct ’08 Apr-Oct Apr-Oct

Sector (%) % % ’07-’08 ’08-’09
in IIP growth growth % growth % growth

Crude Petroleum 4.17 -0.1 -0.3 0.6 -0.7

Refinery Products 2.00 2.7 5 8.8 4.5

Coal 3.22 8.9 10.9 3.7 8.4

Electricity 10.17 4.2 4.4 7.1 2.8

Cement 1.99 7.5 6.2 8.5 6.0

Finished Steel
5.13 5.2 -0.5 7.3 4.2
(carbon)

Overall 26.7 4.6 3.4 6.6 3.9

Source: Infra Growth Dips to 3.4% in October, Business Standard, 12 December 2008

From the above figure it is clear that the overall growth rate of the infrastructure
industries declined from 4.6% in October 2007 to 3.4% in October 2008. There was a
massive decline in the growth rate of steel production from 5.2% to a negative growth of
-0.5%. It is seen that the growth rate of cement production also declined from 7.5% to
6.2% in the same period.

The above two tables show that there has been very significant slowdown in the
industrial sector growth rate in India, which is almost spread across the board. In order
to understand the nature of this decline in the growth rate of industrial production, let us
first look at the Use-Based categorization of the IIP figures. This is shown in the
following table:
Source: Press Note -: Quick Estimates of Index of Industrial Production and Use-based
Index (Base 1993-94=100) for the month of October, 2008. Available at:
http://pib.nic.in/release/release.asp?relid=45554

From above table it is seen that all categories of industries witnessed decline in their
growth rates in October 2008 as compared to October 2007. The most noteworthy
aspect is the fact that there has been a drastic decline in the growth rate of capital
goods industries, which declined from a very high figure of 20.9% in October 2007 to a
low figure of 3.1% in October 2008. if we consider the intermediate industries, then also
a similar picture emerges, where the growth rate declined from 13.9% ion October 2007
to a negative growth rate of -3.7% in October 2008. Similar is the story of the consumer
goods industries, where the growth rate declined from 13.7% in October 2007 to -2.3%
in October 2008. Within the consumer goods sector, the growth rates of both consumer
durables as well as non-durables turned negative in October 2008, while both these
growth rates were quite high in October 2007.

The question is what explains this overall slow down in the growth rate of industrial
production in India. Firstly, it must be remembered that the Indian economy has been
adversely affected by the global financial crisis. It has been the case that as a result of
the global economic crisis, there has been a crisis of credit even in the Indian economy.
As a result, banks have become more stringent in giving loans to individuals or
companies to meet their consumption or investment needs. This has adversely affected
the investment decisions of firms and companies. As a result we are witnessing that the
growth rate of production of capital goods industry has declined sharply in the country.
Capital goods production essentially depends on the investment decisions of firms. In a
situation where the overall economic scene is positive,firms increase their investments
which get reflected in an increase in the production of capital goods. By the same logic, a
sharp decline in the production of capital goods essentially shows that firms are less than
forthcoming in taking up new investments.

Why have firms become reluctant in taking investment decisions? One reason for firms’
reluctance to make investments has been already mentioned in the previous paragraph
which is in terms of higher interest rates on loans. There is however an additional reason
for this reluctance, which is the following. Investment decisions of firms are based upon
expectations of the future which in turn is formed on the basis of the demand
performance at the present. If at present, there is a drop in demand, then for the firms
this will manifest itself as an increase in their unutilized capacity and/or a build up of
their inventories.In this case, the firms perceive that their earlier investment decisions
were overestimates, since there exist unutilized capacities and therefore they cut back
on investment decisions. To some extent this is currently happening in the Indian
economy. We have seen how big firms like TATA Motors or Ashok Leyland closed down
their units for some days or JSW steel cutting production and so on and so forth. This is
nothing but a manifestation of a demand problem, which is reflected in the fact that the
growth rate of the consumer goods sector has turned negative in October 2008 from a
very high level in October 2007 as has been shown in the above table.

Now, the question is what accounts for the fall in the demand in the Indian
economy,which is reflected in the drastic fall in the growth rate of consumer goods. It
must first be noted that the demand in the Indian economy which has led the good
growth performance of the last few years is very narrowly based. It stems mainly from
the demand of the rich and the middle class based upon easy loans made available to
them by banks. Now, with the global financial crisis hitting India, the banks stopped
giving easy loans which has resulted in the decline in demand for consumer goods,
particularly consumer durables in India. At the same time, with massive poverty
existing, particularly in the Indian countryside, there is very little demand that this
segment of the population generates. Therefore, what is needed is a plan of action which
tries to put more purchasing power in the hands of the poor, whose demand can then
increase the overall demand base in the economy and lead India towards a sustained
demand led growth.

On the other hand it has also been the case that in the fact of global recession,
particularly in the USA, India’s exports have also been badly hit. In fact the export
growth in October 2008 has been negative, the lowest in many years. So, the external
demand for Indian industrial output has also not been strong enough.

It can however be argued that since the demand in India was largely based on the
consumption of the rich and middle class on the basis of soft loans, what is essential is
interest cuts, which will then automatically increase the demand in the economy. This
however is not necessarily the case. The present crisis is a crisis of confidence, where
even with low interest rates, banks might just refuse to lend to any borrowers other than
the truly credit worthy one. On the other hand, given the uncertainties in the market,
the borrowers are also less than willing to take such loans. In other words, only an
injection of liquidity in the market may not solve the problem, since people may just
hold on to the excess liquidity without creating any demand, a case which Keynes called
the liquidity trap. The current world as well as the Indian economic situation is akin to
this phenomenon. (See, ‘In Search of a real Stimulus’, Jayati Ghosh,
http://macroscan.com/cur/dec08/cur11122008Stimulus.htm).

Another argument can be made at this point which is the following. Even if it is granted
that by a mere reduction of interest rates will not solve the problem,the current stimulus
package announced by the Government will take care of the problem which talks about
an additional fiscal stimulus and also tax cuts in the form of a cut in excise duties.
Firstly, it needs to be pointed out that the fiscal expenditure of Rs 20,000 crores planned
by the Government is only 0.5% of the IndianGDP and is grossly inadequate to quell the
crisis. Secondly, the tax cuts in terms of cuts in excise duties will increase demand only
if they are passed on to the consumers through a price cut. More importantly, however
such cuts in the excise duties is aimed at only a short term solution of giving rise to a
demand bubble based on lower prices. But it completely ignores the aspect of increasing
the purchasing power of the poor by direct intervention of the state in funding the Public
Distribution System, expenditure in rural areas etc. In short the current stimulus
package is inadequate to meet the serious problem that the economy is in right now.