Around a week back, the ministry of statistics and programme implementation came up with estimates of the gross domestic product(GDP) for 2016-2017. The GDP is expected to grow by 7.1 per cent in comparison to 7.6 per cent in 2015-2016. This estimate does not take the negative impact of demonetisation into account. Once demonetisation is taken into account, the economic growth (as measured by the GDP growth) is likely to be significantly lower than 7.1 per cent. But that is a debate we will leave for another day and right now concentrate on the 7.1 per cent economic growth figure.
A GDP growth rate of 7.1 per cent in a slow-growth world that we live in, is pretty good on the face of it. The International Monetary Fund’s World Economic Outlook expects global growth to be at 3.1 per cent in 2016 and 3.4 per cent in 2017. At 7.1 per cent India’s economy is growing at a significantly faster rate.
Nevertheless, there are serious problems with this economic growth. Allow me to explain.
The GDP, or the size of any country’s economy, can be measured in various ways. One is through estimating the size of various industries. The other way of measuring the GDP is by measuring the different kinds of expenditure. This essentially is the sum of the private consumption expenditure, the government expenditure, investments and the net exports (i.e., exports minus imports).
Take a look at Figure 1. It essentially plots the gross fixed capital formation as a percentage of real GDP (or GDP which has essentially been adjusted for inflation).
Gross fixed capital formation is basically a proxy for the investment happening in the economy.
What does Figure 1 tell us? It tells us very clearly that the investment as a percentage of GDP has been falling over the last five years. It is now down to around 29.08 per cent of the GDP. In fact, in 2015-2016, investment was at 31.2 per cent of the GDP, from where it is expected to fall to 29.08 per cent of the GDP in 2016-2017. In absolute terms, the gross fixed capital formation or investment is estimated at Rs 35.35 lakh crore in 2016-17 in comparison to Rs 35.41 lakh crore in 2015-16, down by 0.2 per cent.
A part of this fall has been made up for by an increase in government final consumption expenditure. In real terms, this expenditure is estimated to be at Rs 13.95 lakh crore in 2016-2017. It was at 11.27 lakh crore in 2015-2016. Take a look at Figure 2.
Figure 2:The government expenditure has jumped from 9.93 per cent of the GDP in 2015-2016 to 11.48 per cent of the GDP in 2016-2017. This is the major reason why the government still expects India to grow at greater than 7 per cent, despite a fall in investment.
In fact, take a look at Figure 3. It makes for a very interesting reading. It essentially shows what portion of increase in GDP between years comes from an increase in government expenditure.
Figure 3: So, what does Figure 3 tell us? It tells us that between 2011-2012 and 2012-2013, increase in government expenditure made up for just 1 per cent of the increase in GDP. Along similar lines the increase in government expenditure between 2015-2016 and 2016-2017 will be responsible for around one-third of the increase in GDP. This has been primarily because the government implemented the one rank one pension rule as well as the recommendations of the Seventh Pay Commission.
Now take a look at Figure 4.
If we take government expenditure out of the equation, how does GDP growth look like? The economic growth for 2016-2017 comes in at 5.2 per cent, which is the lowest in half a decade. The new GDP series currently has data only up to 2011-2012. Hence, this analysis is limited due to a lack of data.
What this tells us is that the economic growth in 2016-2017 is likely to come in at 7.1 per cent, primarily because of the government expenditure forming nearly one-third of the incremental GDP.
The trouble is that this way of creating economic growth by the government spending its way out of trouble, cannot continue indefinitely. At the end of the day The government has a limited amount of money at its disposal. If India has to continue growing at greater than 7 per cent, then private sector investment needs to pick up and that doesn’t seem to be happening currently due to various reasons.
There are several short-term factors holding Indian investment back. The capacity utilisation rates of the manufacturing sector continue to remain low. For the period from April to June 2016, the 903 companies surveyed by the Reserve Bank of India reported a capacity utilisation rate of 72.9 per cent. With more than one-fourth of the capacity lying unutilised there is no reason for Indian industry to invest and expand. Over and above this, large sections of Indian industry, especially those operating in the infrastructure space, continue to remain highly indebted to banks.
These and other reasons are holding investment back. And this is unlikely to change anytime soon. Also, growth in investment is necessary if jobs are to be created for India’s youth who are entering the workforce in a huge number. It is estimated that every month one million Indians enter the workforce. Where are the jobs for them going to come from if investment as a proportion of the economy continues to shrink?
The column originally appeared in Equitymaster on January 12, 2017.