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Students Corner - A Decade of Economic
Reforms in India - A Review

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Cyclical factors have generally been recognised as an important source of industrial slowdown. In this context, the significant fall in Government capital investment especially since 1995, has been recognised as the key contributor to the slowdown (Nayyar, 1996). It is, however, important to underscore that while the contraction in Government expenditure does have adverse implications for the manufacturing growth, it declined even during the manufacturing boom (1992-93 to 1995-96). Thus, decline in Government expenditure per se does not provide a satisfactory explanation of the slowdown.

The manufacturing slowdown can also be seen in terms of decline in fixed investment in industry in the context of over-expansion of capacities during the manufacturing boom, slump in the capital market for new issues and rise in real interest rates in 1995-96 (Acharya, 2002). The increase in real fixed investment in manufacturing from 6.8 per cent of GDP in 1990-91 to 13.0 per cent in 1995-96 and the subsequent decline to 7.9 per cent by 2000-01 seems to have mirrored the pattern of manufacturing growth.

Among the other cyclical sources of demand, the lagged effect of the negative agricultural growth in 1995-96 seems to have worked towards slowing down the growth of rural demand for consumer durables and non-durables subsequently (Government of India, 2000). As the demand for industrial products, particularly the consumer durables, is significantly influenced by the rural demand, fluctuations in the agricultural production seem to have adversely impacted the industrial growth.

The cyclical downswing was not confined to the domestic sources of demand but was also clearly visible in manufacturing exports. In anticipation of high potential demand in the wake of reforms, the manufacturing sector built up huge capacity through imports of capital goods during 1994-97. Such capacity build-up was not sustainable on the basis of normal growth in domestic demand, and the only feasible outlet was the exports market. However, signs of exports slowdown were visible in 1995-96 when manufacturing exports decelerated. Subsequently, with slowdown in the world trade, sluggishness in the global manufacturing prices and variations in the cross-currency exchange rates, manufacturing exports growth declined to a meagre 3.6 per cent by 1996-97. The real appreciation of Rupee between 1993 and 1995 and the Asia-wide slowdown in exports following the loss of market share to China also contributed to the slowdown in export

As is evident from the foregoing analysis, the growth momentum in manufacturing slackened towards the end of 1996, largely under the influence of factors outside the realm of public policy in the short-run. The movement in major indicators of aggregate demand, viz., domestic capital formation, Government capital expenditure, capital goods production, import of capital goods, manufacturing exports and private final consumption expenditure, all witnessed deceleration during the latter phase of the reforms. Some empirical evidence of the determinants of industrial demand is set out in Box III.4.

To the extent the slowdown is prolonged and protracted, it seems to have its origin in structural factors, including, inadequate industrial restructuring undertaken in the face of growing openness of the economy and the associated external competitive pressure. The inadequacy of institutional and structural reforms, which held back the industrial restructuring, has, thus, emerged as a binding constraint on manufacturing growth in the liberalised trade regime.

The industrial performance continues to be hampered by physical infrastructure bottlenecks with the demand-supply imbalances persisting and growing during the reform period. A worrisome feature of infrastructure development has been the declining trend in potential output of a number of basic activities such as steel, coal, cargo handling and freight loading. There are, however, signs of improvement for a few sectors, like power and communication. With the initiation of power sector reforms, the demand-supply gap for power has witnessed a decline to 7.9 per cent during the reform period from 8.9 per cent during the pre-reform period. Notably, the power deficit remained high at around 9 per cent during the mid-1990s when the industrial sector was growing at a faster rate (Chart III.25). The downtrend in demand-supply gap for telecommunications accompanied by a decline in unit cost reflects the regulatory reforms and increased competition arising from private sector participation.

The deteriorating infrastructure services represent a direct fall out of shrinkage in infrastructure investment in the context of grossly inadequate internal resources of public infrastructure entities and dwindling Plan outlay for infrastructure. The real capital formation in electricity, gas and water supply declined to 2.6 per cent of GDP during the 1990s from 2.9 per cent during the preceding decade. A similar trend was observed for railways. Within the 1990s also, there was a decline in the real gross capital formation in sectors like electricity, gas and water supply, and the railways between the first and the second half. In contrast, communication witnessed an improvement in the reform period following the market based pricing of services and better regulatory framework. The investment in infrastructure sector as a whole has shown clear decline of one percentage point of GDP between the first and the second halves of the 1990s. This decline can be attributed to declining government investment on infrastructure - a fall out of the prevailing fiscal situation - which was a major contributing factor for the economic slowdown in the latter part of the 1990s.

The pace of public investment in infrastructure slowed down substantially during the reform period on account of rising fiscal imbalances of the Government, both at the Centre and the States. As a result, public investment in major infrastructure sectors declined in real terms during the reform period. The rates of return from infrastructure services extended by the Government continue to be abysmally low, constraining the ability to generate internal resources for investment. For instance, the rate of return on investment for the State power sector deteriorated from (-)12.7 per cent in 1991-92 to (-)32.8 per cent in 2001-02. These essentially indicate lack of required structural reforms in the power sector in India, notably the near absence of market based pricing.

Contemporaneously, response of the private sector to the reform process has not been adequate to offset the declining public investment on account of inadequate institutional reforms, lack of clarity regarding infrastructure development priorities, non-transparency in project outsourcing processes, and numerous time consuming clearances. In the absence of rationalisation of user charges, the infrastructure sectors such as railways, public transport, power continue to suffer from the levy of inadequate user charges, thereby putting off potential private participation. Keeping in view the long gestation period for infrastructure projects, the issue of initial risk sharing by the Government assumes importance, given the inability of the private sector to assess the long-term risks.