India's economy grew below five per cent for the fourth quarter in a row during the July-September period of FY14, even as the gross fixed capital formation (GFCF) rate, a proxy for investment, hovered around 30 per cent of gross domestic product (GDP). Such a level of GFCF is enough to yield a growth rate of seven per cent. It is interesting to note that despite high interest rates and low demand, GFCF has been holding on at about 30 per cent for the past few years.
GDP rose 4.8 per cent in the second quarter of the current financial year, while GFCF stood at 29.4 per cent of GDP. Such a dismal growth of the economy is basically due to rising incremental capital output ratio (ICOR). This means, the capital invested is not yielding the desired output.
Had capital output ratio been four, 29.4 per cent of GFCF would have produced a GDP growth of 7.3 per cent. However, ICOR rose to 6.1 in the second quarter of FY14 from 3.2 in 2006-07. During 2006-07, GFCF at 31.3 per cent of GDP had produced an economic growth rate of 9.6 per cent. 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 because of which projects are either stuck 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.
"Lack of financing and a poor pipeline is due to the current stalemate on various projects. Projects of over 33 Gw are operating below 60 per cent plant load factor, mainly due to fuel issues. This could pose a risk to over Rs 1-lakh crore worth of bank loans, which could turn into NPAs if we don't take action quickly," said KPMG.
Shankar Acharya, honorary professor at Indian Council for Research on International Economic Relations and former chief economic adviser, said a lot of projects were lying idle because of which investment rate was rising but desired output was not coming. This was due to overall inefficiency in the economy and policy inaction, he added.
Citing an example, he said Vendanta had invested in aluminium project in Odisha, but bauxite raw materials were not forthcoming due to tribal unrest.
Recently, Anil Agarwal, who controls London-based Vedanta Resources Plc, said he regretted investing $8 billion on an aluminium complex in India that had 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. According to him, complex government procedures are delaying project approvals in India and impeding companies.
Vedanta Aluminium is running below capacity after failing to get approval from local tribes to mine bauxite.
The Cabinet Committee on Investments (CCI) was set up earlier this year to clear the stuck up projects. It has so far cleared projects costing over Rs 3 lakh crore.
Will these lower ICOR and result in desired growth rate? According to Gokarn, it depends on what kind of projects CCI is clearing. The issue depends on whether CCI is clearing the projects causing bottlenecks and whether these are implemented after getting CCI clearance.
The CCI has so far cleared projects relating to power, oil, road among others.
Acharya said it would be worthwhile to see on the ground 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 the payment made by the developer to the National Highways Authority of India in build, operate and transfer (BOT) projects. The premium, which is offered by companies during the bidding stage, is based on projected returns from tolls.
GDP growth for FY12, FY13 and the first half of FY14 has been 6.2 per cent, five per cent and 4.6 per cent, respectively. Even if one takes the average for this period, and not the latest quarter, a growth of 5.8 per cent 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 per cent of GDP.
Does it mean 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 the economy has a potential to grow at eight per cent but it is expanding below five per cent, he said.