The most basic law of economics is that of supply and demand. It provides an adequate framework to explain macro-economic cycles. There is always a demand-supply mismatch in a large economy. During periods when demand is soaring but supply is adequate, we have strong growth. When demand exceeds supply, we have overheating and inflation and that prompts the creation of new capacity. When supply again exceeds demand by substantial amounts, we have recessionary conditions. Then demand starts to catch up all over again and the cycle repeats.
This is all very easy and obvious to understand in theory. In practice, a full cycle may last two years; it may last 10; we can rarely estimate when things are turning around. For example, several sectors of the Indian economy built massive over-capacity during the 1995-97 period at the end of the 1993-96 boom period. That supply (along with productivity gains) was adequate to feed demand until 2006-07 at least. In between, we've had several mini boom-busts and capacity expansion has continued in other sectors.
The figures in the 2007 Economic Survey and a glance at the corporate results through the first three quarters of 2006-7 both suggest that supply is now close to being exhausted in several key areas. This year, we're likely to see capacity constraints across several sectors. This implies that, despite the best efforts of the FM, (not that the 2007-08 Budget is anything to write home about!), overheating could continue until new supplies flow into the system.
The Economic Survey makes it very clear that growth is driven almost completely by demand and investment generated by the private sector. India has a savings rate of about 31-32 per cent and about 29 per cent of that is contributed by household savings (22 per cent) and private corporate sector (6.8 per cent). About 70per cent of total economic activity is driven by the private sector -the aam admi and India Inc. pulling themselves up by their bootstraps.
Some of key growth areas have been telecom services, automobiles and housing, and in turn, these industries have fuelled high offtake in financing, in metals, cement and in the construction services sector. Telecom off its own bat has absorbed enormous investments both in network creation and in services rollout and it has made a very high contribution to productivity gains across the economy.
Demand continues to be strong everywhere. Telecom services are signing up about 6 million new customers every month. The constraints inhibiting faster growth are spectrum release and clarity on the policy front. That is what is leading to consolidation - a new licence is worth less than an extant licence due to the spectrum policy. And of course, an existing subscriber base is worth a lot because retention is less expensive than acquisition.
Auto sales across two/three/four-wheelers inclusive of commercial vehicles grew 15-20 per cent in unit terms across all categories in the first nine months of 2006-07. That was over and above similar 15-20 per cent growth in both 2005-06 and 2004-05. About 70 per cent of vehicle buys were financed. The auto industry's offtake is running at about 95 per cent of total rated capacity. Auto prices have seen hikes across the board but demand is still evident. Housing finance remains the fastest growing segment of the financial sector and non-food credit has grown at over 30 per cent per annum for the past three fiscals, including the incomplete 2006-07. Interest rates have risen considerably through the past 18 months but that has not choked the demand for funding.
The new thrust on pouring cash into rural and agricultural segments will make it difficult for lenders to find wherewithal to fund more loans to retail urban customers. This is accentuated by the Reserve Bank's policy of hiking CRR and policy rates and provisioning norms.
Cement offtake ran at 102 per cent of rated manufacturing capacity across the first 10 months of 2006-07. This makes the strange dual-rate excise policy laughable. Against the current rate of a flat Rs 400/tonne excise, the Budget imposed a lower excise rate of Rs 350/ tonne if prices were held at Rs 190/ 50-kg bag or less. In addition it imposed a rate of Rs 600/tonne if prices were above Rs 190. With prices ruling at Rs 206/ bag pre-Budget, the industry just raised prices to Rs 222 to pass on the hike. In steel too, where a similar though less drastic situation is evident, the government is attempting to arm-twist prices down.
Capacity expansions are evident across all the manufacturing industries. But in each case, it will take a certain amount of time for the capex to be in place and operating. Until then, incremental demand will be tough to satisfy. It is difficult to see how industry can ramp up to deliver growth until such time as new capacity comes online. I think further price hikes at the manufacturing level are inevitable.
This article was originally published on March 01, 2007.
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