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July 2012

CRISIL Insight



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Why is it critical to revive the private sector?

Private Sector

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Why is it critical to revive the private sector?

Insights from National Accounts Data Key Messages

A bounce-back in private sector investments and its contribution to growth is vital for creating an upside to Indias currently weak economic prospects. The public sectors ability to lift growth is petering out.

The private sector, which accounts for th of Indias GDP, has played a dominant role in lifting Indias growth during the 2000s. Private sector GDP growth per year went up to 7.7 per cent during the 2000s from below 5.7 per cent during the 1990s whereas public sector GDP growth remained stagnant at 6 per cent during those two decades.

The public sector cushioned Indias growth during the global financial crisis (2008-09 to 2009-10). Without a robust 12.3 per cent growth in public sector GDP (on the back of increased government spending), Indias overall GDP growth would have averaged 6.2 per cent and not 7.6 per cent during 2008-09 to 2009-10. By contrast, private sector GDP growth had slipped sharply from its pre-crisis levels of 10 per cent per year to 6 per cent during this period.

The rising deficits of the government constrain the public sector from supporting the economy by increasing spending. This is evident from the decline in public sector GDP growth to 6.5 per cent in 2010-11 from 14.5 per cent in the previous year. Consequently, the sustainable upside to growth will be largely shaped by the revival of private sentiment and investments.

Removal of policy bottlenecks and speeding up project clearances, complemented by faster pace of economic reforms are some of the measures that can help revive private sector sentiment and GDP growth. Economic reforms and steps to tame inflation on a durable basis will create some upside to the depressed growth outlook for 2012-13 and also lay the foundation for healthy and sustainable growth ahead.

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Key Messages Rising role of private sector in the 2000s Global Financial Crisis (GFC) brought public sector back into prominence What lies ahead? Annexure Long-term trends in growth and investments in public and private sector

1 3 4 5 6 6

Rising role of private sector in the 2000s

For India, the first decade of this century was a watershed in many respects. It started with a below-trend growth rate of 5.5 per cent between 2000-01 and 2003-04, but later surprised on the upside when the economy expanded at a neverbefore-seen rate of nearly 9 per cent per year between 2004-05 and 2007-08. Then the global financial crisis intervened and dragged down growth to 6.7 per cent in 2008-09. But the economy recovered swiftly and forged ahead in the next two years with 8.4 per cent growth. As the next decade dawned, growth slipped again. GDP growth was at 6.5 per cent in 2011-12 and the prospects are equally weak for 2012-13. The role of the private sector and the public sector in shaping investments and growth during the decade of 2000s is a study in contrast. During 2004-05 to 2007-08, when Indias overall GDP was growing at an average rate of 8.8 per cent, private sector GDP expanded by about 10 per cent compared to 6 per cent in the public sector. During this period, there was also a sharp surge in private investments, particularly from the private corporate sector. Private corporate sector investments grew to 17.3 per cent of GDP in 2007-08 from 10.3 per cent of GDP in 2004-05. This quantum jump in investments was significantly funded by increased savings/retained earnings of the corporate sector, which rose by 2.8 per cent of GDP during the same period. Private corporate sector, thus, played an important role in lifting savings and investments in the economy and, thereby, growth. Table 1: GDP growth in public and private sector since 2004-05
2004-05 to 2007-08 Public Sector Private Sector Total GDP Source: CSO 5.9 9.7 8.8 2008-09 to 2009-10 12.3 6.2 7.6 6.5 9.0 8.4 2010-11

Table 2: Savings and investment rate got a boost from private corporate sector
2004-05 Public Sector Household Sector Private Corporate Sector Total 2.3 23.6 6.6 32.4 2005-06 2.4 23.5 7.5 33.4 2006-07 3.6 23.2 7.9 34.6 2007-08 5.0 22.4 9.4 36.8 2008-09 1.0 23.6 7.4 32 2009-10 0.2 25.4 8.2 33.8 2010-11 1.7 22.8 7.9 32.3 Savings (As % of GDP)

Investment (As % of GDP) Public Sector Private Corporate Sector Household Sector Total Source: CSO 7.4 10.3 13.4 32.8 7.9 13.6 11.7 34.7 8.3 14.5 11.9 35.7 8.9 17.3 10.8 38.1 9.4 11.3 13.5 34.2 9.2 12.7 12.4 36.6 8.8 12.1 12.8 35.1

Note: Components of investments do not add up to total due to errors and omissions

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The critical role played by the private sector during the boom years from 2004-05 to 2007-08 becomes even more evident when one takes a closer look at manufacturing growth. During this period, private sector manufacturing grew by a remarkable 12.4 per cent, expanding Indias manufacturing sector by 10.5 per cent despite a 0.1 per cent contraction in public sector manufacturing. During 2004-05 to 2007-08, the burden of driving Indias manufacturing growth was borne almost entirely by the private sector, which contributed over 95 per cent of manufacturing investments a significant rise from 73 per cent in the 1980s. A similar trend was observed yet again in 2010-11, when the manufacturing sector expanded by 7.6 per cent driven by a 10 per cent growth in private sector manufacturing, despite a 12 per cent contraction in the public sector. Figure 1: Manufacturing growth

Source: CSO

Global Financial Crisis (GFC) brought public sector back into prominence
The aftermath of GFC changed the growth dynamics as public sector GDP bounced back
The GFC brought down the overall GDP growth to 6.7 per cent in 2008-09 from 9.3 per cent in 2007-08. The 10.2 per cent growth in public sector GDP that year played an important role in cushioning the economy as private sector GDP growth had fallen to 5.8 per cent. Public sector GDP expanded by 12.3 per cent per year during 2008-09 to 2009-10 compared to only 6.2 per cent growth for the private sector. Private corporate savings and investments dropped sharply during 2008-09 (Table 2). The drop in corporate investments by 26 per cent in 2008-09 over the previous year was much sharper than the fall of 11 per cent in corporate savings in the same period. Clearly, corporates were preserving cash rather than investing. This kind of behaviour of corporates can be attributed to cash preservation that typically happens in a high risk environment. Had the public sector growth rate not risen (via increased government spending and increase in wages of public sector employees through implementation of Sixth Pay commission and other stimulus), overall GDP would have grown at 6.2 per cent per year instead of 7.6 per cent during 2008-09 to 2009-10. With the gradual withdrawal of stimulus in 2010-11 and petering off of the one-time effect of the Sixth Pay Commission, public sector GDP growth fell to 6.5 per cent. GDP growth in public administration and defence had gone up to 19 per cent per year during 2008-09 and 2009-10 from 5.1 per cent in the preceding four years. The real wages (after adjusting for inflation) of Central and state government employees grew at an average rate of 17 per cent per year in these two years. In 2010-11 as the as the one-time impact public sector wage hikes wore off, GDP in public administration and

defence fell to 1.3 per cent with public sector wage growth at 3.8 per cent. However, private sector GDP growth rebounded to 9.0 per cent during the same year due to improved private demand and some rebound in external demand. Both savings and investments of the private corporate sector went up (as per cent of GDP) in 2010-11 but were much lower than the pre-GFC levels.

Figure 2: GDP growth

GDP Growth (%) 14 12.3 12 10 8 6 4 2 0 Public Sector Private Sector 5.9 9.7 9.0 2004-05 to 2007-08 2008-09 to 2009-10 2010-11



Source: CSO

What lies ahead?

We do not have the GDP data break-up for public and private sectors for 2011-12 but we do know that overall GDP growth fell to 6.5 per cent in 2011-12 from 8.4 per cent in 2010-11. By a reasonable guesstimate, therefore, public sector GDP would have grown at best around the same level as in 2010-11 (6.5 per cent) and private sector growth would have fallen significantly to similar levels of 6.5 per cent from 9.0 per cent growth recorded in 2010-11. What does this mean for 2012-13? Given the tight fiscal position of the government, it means that the ability of the public sector to give impetus to growth by increasing spending is limited. Persistently high inflation implies that the monetary policy via interest rates cuts can play a limited role in revising growth. The depressed global outlook rules out any external stimulus to Indias growth rate. Under these circumstances, a return to the pre-crisis growth rate of 9 per cent looks like a distant dream. The economy still has the potential to grow at 7.0-7.5 per cent (RBI, 2012), much above the current rate of GDP growth of 6.5 per cent. An improvement in private sector sentiment and pick-up in private sector investment can lift private sector GDP and, hence, the overall GDP growth. This is particularly important for revival of manufacturing activity where private sector plays a dominant role. Overall manufacturing growth collapsed to 2.5 per cent in 2011-12 and was -0.3 per cent in the fourth quarter of the fiscal. Since 90 per cent of the GDP in manufacturing originates in the private sector, a sustainable revival of private sector manufacturing growth will be extremely critical for achieving the ambitious objectives of New Manufacturing Policy (NMP), which aims to raise the share of manufacturing in Indias GDP to 25 per cent by 2025 from 16 per cent currently.

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Policy bottlenecks, slow clearance of projects and rising inflation have dampened private sector sentiments and stifled investments in recent years. These issues need to be urgently addressed to create some upside to the depressed investment outlook for 2012-13. To lay a healthy foundation for higher and sustainable growth over the medium run, these steps will need to be complemented with a fresh dose of reforms to raise the supply potential of the economy. What will be public sectors role? The public sector cannot substitute for the lack of growth in the private sector on a sustained basis. Through increased spending on physical infrastructure (roads, power etc) and social infrastructure (health and education), public sectors role will be to create an enabling environment for the private sector to accelerate investments.

Long-term trends in growth and investments in public and private sector
Private sector lifts Indias growth in 2000s
Indias overall GDP growth went up to 7.3 per cent per year in the decade of 2000s from 5.8 per cent in the preceding decade, propelled by the private sector. While public sector GDP growth improved marginally to 6.3 per cent per year during the 2000s from 6 per cent during the 1990s, private sector GDP growth surged to 7.7 per cent in the 2000s from 5.7 per cent in the 1990s. One clear differentiator of the two decades is the dominant role played by the private sector in driving Indias GDP growth. Table 3 : Private sector propelled Indias GDP growth in 2000s
1980s Public Sector Private Sector Total Source: CSO 7.4 4.8 5.4 1990s 6.1 5.7 5.8 2000s 6.3 7.7 7.3

Savings and Investment too get a boost from private sector

Table 4 : Savings and investment
1980s Public Sector Private Corporate Sector Household Sector Public Sector Private Corporate Sector Household Sector Source: CSO, 2012 4.1 1.9 14.5 12.2 4.7 7.3 1990s 1.8 4.0 19.3 9.6 7.7 8.8 2000s 1.3 6.5 23.8 8.2 10.5 12.6 Savings (As % of GDP)

Investment (As % of GDP)

In the decade of 2000s, for the first time since independence, there was an increase in the contribution of the private sector to Indias GDP. The private sector accounts for the bulk of Indias GDP but its contribution to GDP had continued to fall since the 1950s. This was clearly an outcome of policies aimed at nurturing the public sector. What is intriguing is that even in the decade of 1990s, associated with reforms to increase the role of private sector in the economy the contribution of the private sector to Indias GDP fell to 75.5 per cent from 77.0 per cent in the eighties. So, it took an entire decade after the launch of reforms for the private sector to increase its contribution to the countrys GDP.




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