Subir Gokarn is the chief economist of Crisil, India's oldest and largest credit rating company. In that capacity, he heads the Crisil Centre for Economic Research, based in New Delhi. He also oversees Crisil's portfolio of research businesses, which include an industry research unit and a corporate research unit.
Prior to this position, he was chief economist and IFCI Chair in Industrial Development at the National Council of Applied Economic Research, New Delhi (2000-02) and Associate Professor at the Indira Gandhi Institute of Development Research, Mumbai (1991-2000).
In an interview with Equitymaster, Gokarn spoke about the current economic recovery and how sound it is. He also shared his views on agriculture and industrial sectors and whether this industrial recovery is for real.
The Indian economy is expected to grow at a faster rate in FY04, partly led by fundamental factors and partly by one-off reasons. What are things that have to fall in place for this growth to sustain for another 5 to 10 years?
I think part of the process is already in motion and that's what explains the fundamental recovery. This year's performance is partly one off and partly structural.
The structural component comes out of two basic drivers, i.e. the interest rate scenario and the public expenditure scenario. The scenario looks fairly stable going forward because of powerful changes in the financial sector, fairly innovative funding models for infrastructure spending.
All of these combined do not leave this growth vulnerable to a quick reversal. Of course, we will not get the same kick we got this year because they will plateau in terms of their impact, but they are still in sustenance. They will contribute to the industrial growth that we are seeing now.
So the cyclical recovery could turn out to be a structural recovery?
The interest rate was a very important contributor and the spending on roads has been good. As long as they are sustainable, they are providing reasonable industrial growth. That is what is already at work. But what is not at work is investment. And that is where I think the mystery is still unresolved.
Whatever we are seeing in terms of capacity utilisation would lead us to believe that sooner rather than later, the capacity has to start coming on stream. And given the sustainability of these two drivers, most investment expectations should be positive. If growth is going to be fairly stable over the next three years to five years, then it is worth your while going in for capacity expansion so that the business risk of new expansions are not very high.
That equation seems good on paper, but is not translating into real action. Why that is not happening is because of two or three factors.
One is that trade is a very critical factor in investment decisions. If you can import it, why make it? The risk or the threat of import competition is high in many sectors. One reason why you are seeing such a boom in auto is because of the fact that you have still got very high import tariffs.
Basically, you see investment happening in sectors, which have high protection wherein auto sector is a striking example. The other factor is what I would call 'system capacity', which is that the large assembly producers (people who are producing goods that are assembled) are really trying to outsource their production as much as possible.
So, what's happening is that a lot of the small and the medium industry that's lying around somewhat underutilized, is emerging as a vendor network to the larger corporate. And so, there is no great pressure for new capacity within these large corporates. It is not to say that it is not good. It is great thing because you are using underutilized capacities. So, it is a productivity enhancement, not a new capacity expansion.
Three, I think the infrastructure problems are still very significant. The power bill has made a lot of difference in terms of facilitating trade. So, a lot of captive capacity that was created over the last decade will now become an economic user of commercial aspect, i.e. people can sell captive power now. So, that's going to have an immediate sort of a very short-term positive impact.
But even with that, ultimately, in three to five years, it will have its full impact in terms of generation capacities and the freedom from scarcity from power.
Is the investment cycle really favorable for the long-term? What is your view?
I am making a more general point about the barriers to investment or the constraints to investments. So, in power, if you start thinking three to five years ahead, obviously, people who are heavily dependent on power, once they start to see these plans, they will start initiating investment projects. I am sure it will start to accelerate the process.
In others, particular to industries that are highly labour intensive and where you need to get into very large scale operations like garments and so on, the labour issues, the industrial dispute act, is a very big problem. So, there are four or five reasons, not all of them uniform across sectors.
But when you add up all these reasons, when you look at sectors that are impacted by one or more of these factors, you realize that investment at this point is rather a risky proposition.
Can this import threat be negated? At the end of the day, companies like say GM can set up shop in India and then export abroad. That could be viable. Imports need not be a threat in some industries per se. . .
When Mr Immelt of General Electric was here last year, he had said categorically that China is our manufacturing outsource. India is for knowledge outsourcing or a research outsourcing. It is going to happen, but this is not a big boom that some people might expect. I don't think that is very realistic.
Agriculture, one of the three legs of the Indian economy, has shown erratic performance in the last five years.
Though the contribution to GDP has declined over the decade, 70 per cent of the population relies on this sector for income. Given this backdrop, could you throw some light on the ground realities in the agricultural sector and how do you see this sector performing over the long term?
From a long-term perspective, we are in a rather precarious state. This is basically got to do with the vicious circle of bad incentives. Procurement and subsidies of inputs is leading of obvious over cultivation of cereals.
Even though you may not eventually sell it to the Food Corporation of India, that possibility always exists in the mind. You have a downside protection there. So, there is over cultivation of cereal. Wheat and rice are over cultivated which is leading to the kind of surplus stock that you are seeing.
Due to the politics of sugar pricing, there is over cultivation of cane as well. As a result of this, there is a tremendous drain on the water resources. All of these crops are very water intensive.
Ideally, from an agro economic perspective, growing these crops in many of the areas where it is now being grown has a huge impact on the water system. The long-term prospects in the absence of any major intervention are declining yields and all of the problems associated with that.
Forget productivity growth, you are not even going to get productivity maintenance. There is a large element of man-made problem. I think we need some very fundamental re-thinking on agricultural policy to get out of this trap.
So what is going to happen to the 70 per cent of the population that relies on agricultural income?
No, that's the other thing. It is important to realise that obviously, farmers who depend on agriculture for their livelihood, have sensed that this is a declining proposition. There has been fair amount of diversification in the economy itself in terms of people being forced to move out of their farms, or maintain their farms but look for income elsewhere. I think it is quite a visible pattern now.
Farmers, cultivators and agricultural labour are finding options to diversify into non-agricultural activities. It is not great; it is not high productivity or anything. But at least it is a cushion compared to the declining productivity of agriculture. It is easy to overstate the dependence on the agricultural sector.
But of course, the significance of those opportunities itself depends on new investments and sort of resurgence in industry and services. If industry does well, then the diversification opportunity will increase even more.
So is the road construction project helping in achieving this objective in some way?
That is a very, very powerful stimulant to rural employment. In fact, I would say that one of the reasons why despite the very disastrous agriculture season last year, industry did not suffer because spending on roads was providing a sort of buffer in the rural economy.
The roads, once they are there, will have a very powerful multiplier effect on the local economy. The number of employment opportunities outside of traditional farming also tends to increase.
What is your take on post-2005 implications on the agricultural sector?
I think agriculture is still not a settled issue as far as WTO goes. We still have very high tariffs. We still have the facility, even within the existing arrangement, to provide a very significant protective wall for the farmers. That's not necessarily the best thing or the right thing to do. But certainly, the instrument exists.
So, you are really going to look at the scenario where it is only the sheer pressure of relative prices that can drive the government to opening up on imports. The kind of buffer we have and the willingness to subsidise food, WTO is not a serious concern.
But keep in mind, from a domestic perspective, as per the government's commitment to FRBM, they will have to start attacking subsidies. I think that provides the best option or the best likelihood of change on this policy. FRBM requires zero revenue deficits in five years and subsidies are entirely on the revenue account.
How sustainable is the industrial sector recovery? Is it broad based? How would you rate the performance of the small-scale sector?
I think that's a very, very critical question. I think the base -- if you look from a macro perspective -- is not a very broad based recovery. It has been dominated by three or four sectors. The other sectors have been a bit volatile, relatively speaking. Even when you have the aggregate growing at 6 per cent and 7 per cent, many sectors are still languishing.
So, the base is not yet a pattern where every industry is rising along with the tide. It is basically auto, steel and a couple of others. That always raises questions about sustainability. If you are narrow based, chances are you will run out of steam.
But, I think on the other side, while it has sustained with these three or four sectors, we do see some signs of broad basing. So, it is not become narrow, if anything, it has become broader. But it is still not at a comfort zone.
Talking of small-scale industry, I think when you look at the sectors that are doing well, some of them have very critical linkages to small-scale industries i.e. auto and transportation equipments, in general. I think even sectors like durables have very strong linkages to the small-scale industry. They are doing I would say, better.
There are also sectors like textiles that are heavily concentrated on the small-scale sector (the power looms, garments). That is not doing so well. I think the overall pattern of recovery clearly reflects on the small-scale sector as well.
The last time when we spoke with Crisil MD Ravi Mohan, he referred to something called the upgrades to downgrade ratio. How is it currently and what can change the mix in the future?
Well, actually, there are two factors. One is of course that ratings are a corporate phenomenon. It is essentially big large companies or public limited companies. So, the corporate sector has done particularly well in this rebound. Profitability has been positively impact by lower interest rate.
We estimate that for the three quarters of the current fiscal year (FY04), about 20 per cent of inflow of bottomline has come from lower interest payments. But 80 per cent, which is a significant story, has come from productivity. So, all of the restructuring, the shock that the corporate sector went through downsizing, really positioned it to take full advantage of the recovery when it started. The response to the new environment has been very powerful.
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