Is industrial growth petering out?

New Delhi, Jan 7 (UNI) The Institute of Economic Growth (IEG) cautions that the current upward industrial growth cycle may be on a reverse tide and the turning point may become visible after this month, giving vent to the view that the slow industrial growth in October last was merely a blip.

The IEG cites several reasons as to why this trend would happen, noting that the growth of Index of Industrial Production (IIP) had shown a fall from 11.3 per cent in September 2006 to 6.2 per cent in October and from 9.8 per cent in the same month a year ago.

Industrial growth has been moving upwards since the last four years -- the longest cycle since the big bang reforms were launched in 1991. Yet the industrial cycle has not reached the peak experienced in 1995-96. If this logic is followed then the industrial growth could continue its upward march.

But the IEG finds several reasons for scepticism. A reason for the slowdown could be found in the theory of business cycles. In the recent years, Indian economy has been integrating with the global economy in terms of both financial and goods market. Hence, the likelihood of strong business cycles, following the movement of world growth output, which is expected to move to a lower growth path as per the estimates of the World Bank.

The other factor is a domestic one resulting from tightening of credit to the housing sector, as a result of the move by the RBI to increase the weightage of risk.

The recent trends in the United States housing sector and its linkages to other sectors is a pointer.

The 'core group' of the industrial sector depends on the hosuing sector and the linkage between the core group and non-core groups of industrial sector is strong. Hence, the IEG says, any adverse impact on the core group would lead to overall industrial slowdown.

The RBI has adopted tight money policy, taking a cue from international interest rate cycles. Following this commercial banks have been hiking interest rates on retail loans and also on their depsoit rates. Thus, the hike in interest rate structure may lead to a slowdown in industrial output in the coming months.

The non-food credit to commercial sector has shown a decline in the current fiscal compared to the previous year. Even total credit (both commercial and government sector) had declined marginally in the current financial year.

A striking feature of this is that credit to government, which was negative for quite some time, is growing a little above four per cent. The econometric study says it was a matter of judgement whether credit to government would have a crowding-out effect on private investments. This would depend on the expenditure pattern of the government.

The IEG says there are no significant investments on the productive sectors. Rather the expenditure seems to have increased on populist schemes and on activities that strengthen human development, which increases productivity with a significant lag.

Hence, the IEG says, the hike in credit to government should mostly have a crowd-out effect on private investments.

The report refers to the demand aspects of the story. From the recent performance of exports, it is clear that this year's industrial growth has been substantially contributed by external demand. As the world economic growth is expected to slowdown, sustainig the current external demand into 2007 is questionable, the IEG says.

Domestic demand is also expected to slowdown due to the hike in domestic interest rates as well as the inflation rate moving upwards. ''The fetival demand in October has been reduced to insignificance. The study attributes this to a shift or lower spending pattern among the Indian middle class. Overall, the demand side story is also not supporting the future high industrial growth,'' the IEG says.

Then there is the issue of 'overheating' which means rising inflation rate on the back of high output growth. In this regard, the IEG says, the RBI might finetune the interest rate policy by hiking the interest rates in such a way that it should be able to contain inflation rate by foregoing marginal growth output. This hike -- which the study says could happen in the last round of monetary policy review -- in the interest rate cycle could peak.

In November and Deecember 2006, the IIP growth could revert back to the high growth path. But that would be due to low base in these two months. ''One needs to wait and watch from january 2007 onwards,'' the IEG says.

UNI