So, India has been outshining China. At least that is what the new GDP data released by the Central Statistical Office (CSO) tells us. According to the advance estimate, the Indian economy grew at 7.4 percent (real GDP at market prices) in 2014-15, up from 6.9 percent in the previous fiscal. During the third quarter of the current fiscal, economic activity slowed compared to the previous quarter, yet managed to clock a growth rate of 7.5 percent.
But in fact these numbers give more reasons to worry than to cheer: They don’t seem supported by other macroeconomic data series. Quite possibly, the high economic growth reflected in the new GDP numbers could in part explain the high inflation of recent months. Another indicator that might explain the GDP growth is the HSBC Manufacturing PMI for India, which has been in the expansionary zone since November, 2013.
The index of industrial production (IIP) is a measure of the economy’s industrial output. IIP was used as a lead indicator for economic activity, at least the industrial sector. It is difficult to reconcile the weak industrial production numbers – 0.1 percent in fiscal 2014 and 2.5 percent in fiscal 2015 (to date) – with 4.5 percent and 5.9 percent industrial GDP growth in the corresponding fiscals. Manufacturing has nearly a 75 percent weighting in the IIP and on average around 79 percent in the industry GDP according to the new data. While manufacturing IIP contracted by 0.6 percent in fiscal 2014, the GDP data shows that the manufacturing sector grew 5.3 percent during the same fiscal period.
One possible explanation shared by experts for the discrepancy in high frequency data series like the IIP and GDP is the fact that there has been an increase in utilization rates and productivity. With increases in productivity, the economy is able to generate more value added, even if the output remains the same. The National Statistics Commission Chairman, Pronab Sen has also attributed this increase in GDP to the efficiency gains.
A look at the CMIE data of the non-financial corporate sector shows that this reasoning has some merit. A very rough estimate of efficiency is the ratio of the cost of raw materials to sales. This ratio will give the cost of raw materials embodied in every Rs.100 worth of sales. This ratio for the manufacturing sector has fallen from 53.9 in fiscal 2012 to 53.0 in fiscal 2014. For some manufacturing subsectors the fall is even sharper. For machinery, for instance, the ratio fell from 54.7 in fiscal 2012 to 51.2 in fiscal 2014. In the transport equipment sector (which includes automobiles) the ratio fell from 62.0 in fiscal 2012 to 60.4 in fiscal 2014. Given the fact that the IIP has remained weak, it would be reasonably fair to assume that output remained more or less the same and the gains stemmed from efficiency improvements. So, maybe Indian business did become more efficient over the last two fiscal periods.
In a recent article, the Reserve Bank of India points out that for manufacturing firms, aggregate net profits have grown by 36.9 percent year on year, while net profit margins have improved during the first half of fiscal 2015, as compared to fiscal 2014. Aggregate sales grew at an average of 6.6 percent during the first half of fiscal 2015 as compared to 4.5 percent in fiscal 2014, while the cost of raw materials increased by 6.5 percent during the first half of fiscal 2015, compared to 2.6 percent in the previous fiscal. Although the cost of raw materials rose at a faster pace than sales did, the ratio of the cost of raw materials to sales fell, from 59.7 in fiscal 2014 to 58.3 during the first half of the current period. At the same time, the ratios of interest and labor costs to sales have increased. The EBITDA to sales ratio has also improved.
Another measure of efficiency in the economy is the Incremental Capital Output Ratio (ICOR). ICOR is a measure of the productivity of capital investments in the economy. A higher ICOR is an indicator of inefficiency – a higher level of investment is needed to produce one extra unit of GDP. ICOR is calculated as the ratio of fixed investments to incremental GDP (at market prices). According to the new GDP series, India’s ICOR fell from 6.6 in fiscal 2013 to 4.3 in fiscal 2015. The fall appears to be much sharper if ICOR is calculated using non-agriculture GDP. This means that over the years investments did become more productive. Even in the old series (with 2004-05 base), ICOR was 7.5 in fiscal 2013 and fell to 6.8 in fiscal 2014. Although it is not advisable to look at ICOR for individual years given its volatile nature, it can provide some idea about productivity trends in recent years.
While the exact reasons for this uptick in the revised data are still somewhat unclear, a broad base is definitely one factor. The gains in productivity discussed above are another. Is so, this is definitely a good news. One of the major reasons for the recent slowdown was a fall in productivity. According to a CRISIL report released last year, ICOR nearly doubled during the recent slowdown, compared to its level of 4.4 during India’s high growth period fiscal 2004 to fiscal 2011. Improving efficiency and productivity gains will be crucial in sustaining growth over the long run.
The author is a corporate economist based out of Mumbai. Views are personal.