The swing from Rangarajan to Jalan
R K Roy
There is a certain longing for a return to the high industrial growth rates of 11.8 per cent reached in 1995-96 and 9.4 per cent in the previous year. The 6.6 per cent growth of 1996-97 is considered unsatisfactory. Industrial production has risen by 6.1 per cent in April-November this year. There is disappointment with the lingering recession in industry.High growth rates are desirable. But it remains that the historical trend growth rate of industry has been around 7 per cent. A point is made that reform did boost the growth rate. There is no reason why the reforming economy should not sustain a high industrial growth rate. A close look needs to be taken at the events after 1990-91. There was the contraction imposed in the wake of the forex crisis. The industrial growth rate fell to 0.6 per cent in 1991-92. It rose to 2.3 per cent in 1992-93 and 6 per cent in 1993-94. Those were the years when investment fell. Consequently, capacity utilisation rose to a very high level. Then came the investment
boom of 1994-95 and 1995-96 triggered by liberalisation. Easy access to imports and a freed capital market boosted investment. Consumer goods industries attracted large investment. (Note that investment decisions were based on high capacity utilisation after a period of investment slack). But new capacity creation outpaced the growth of demand. Consequently, capacity utilisation fell. This is responsible for slowing industrial production to 6 per cent plus, or close to the historical trend rate. To put it differently, if investment rises too fast, there will be a mismatch between production capacity and demand, as is being realised by the automobile industry. First came the rush into large cars. As sales fell below expectations, car makers started scanning the market for small cars. Now there is an investment rush into small cars. There will be a period of overinvestment; but capacity utilisation will rise year after year. Investment first in large cars and then in small cars will boost growth, but there
will be a period of investment stabilisation (and therefore of tempered growth) in automobiles during which capacity utilisation will gradually rise. The short point is that a couple of years of high growth will be followed by two or three years of low growth. But as capacities are created in new industries, the floor rate of growth will rise. Only then will the 7 per cent trend growth be lifted. A one-shot spurt in the trend growth rate will be possible only if industrial capacities are created to sell in the export market. Export sales can result in sustained capacity expansion. If this logic is accepted, the industrial growth rate of 6 per cent plus after two years of high investment-led growth will be seen to be not bad at all. As capacity utilisation rises, there will be a surge in investment, but this time around investors will make a shrewd assessment of domestic demand growth. Before retiring as governor of RBI, Rangarajan tried to beat this logic. He unleashed a liquidity flood by promising a
successive decline in banks' reserve ratio. The objective of doing so, during a period when private savings were in excess of investment, was to hammer down lending interest rates. Rangarajan wanted to boost credit. But the problem was not availability of cheap credit as such; it was low capacity utilisation which was deterring the demand for credit. True, there are now signs of a rise in bank credit to the commercial sector; also of larger sanctions of long term loans by development financial institutions. These could be indicative of rising capacity utilisation in certain sectors, and not merely of rising demand for loans at relatively low interest rates.To be fair to Rangarajan, he was aware of the investment problem which required a rise in public investment. But public investment was being axed under reform. Chidambaram slashed public investment across the board by 5 per cent. (This cutback is being restored in the last quarter of the financial year). Faced with declining public investment,
Rangarajan wanted to kickstart the economy by inducing private investment with relatively cheap interest rates. If the investment problem has arisen because of inadequate capacity utilisation, RBI governor Bimal Jalan's decision to roll back the CRR cut and actually raise the CRR, should not hurt the economy. True, the bank rate hike has given a fillip to lending interest rates. But this will not deter new investment, if capacity utilisation continues to pick up. There are two issues here. First, it is simplistic to assume that industrial production can be sustained at a high rate by waving the magic wand of low interest rates. A high growth rate requires entrepreneurial drive to push up aggregate sales at home and abroad, which, sadly, is not in evidence. Second, new investment signals come from rising capacity utilisation. It is nobody's case that investment decisions will not be quickened by lowering lending interest rates. High interest rates put long gestation projects out into the cold. This is what
Jalan must avert. The current dear money policy must be a short term one. A prolonged regime of high rates will result in a loss of investment drive.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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