The disturbing fall in capital formation

The RBI is the key repository of financial sector big data However, this has not been used to even acknowledge, let alone respond to, the gradual hemorrhaging of Indian industry, thanks to the flood of Chinese imports. Information failure on the systemic impact of massive under-invoiced imports from China has led to an inadequate policy response.

Big Data could have been used to highlight the divergence between poor real industrial growth on the one hand and high financial growth on the other --- an aspect that could have been brought to light through corporate financials, capex, cash economy and NPAs.

Corporate financials

Capital accumulation determines technological progress, level of automation, productivity, long-term competitiveness and output growth. Since FY1951, the RBI has been annually analysing financials of selected non-government non-financial public limited companies. These companies’ financials show a steady decline in the share of gross fixed assets in total assets since FY 2004. This share declined from the annual average of 69.4 per cent during the 53-year period of 1951-2003 to 55.2 per cent during 2004-16.

On decadal average basis, this share varied in the narrow range of 66.6 per cent to 73.5 per cent for the five decades ending 1990s. However, it declined to 49.4 per cent for FY 2011-16 — a 20 percentage points fall compared to that in FY1951-2003. There was corresponding increase in the share of financial assets (5 per cent to 15 per cent) and cash and bank balances (4.1 per cent to 5.4 per cent) in the total assets over the same period (see Table).

The RBI did not decipher the serious implications of the steadily declining capital intensity since FY 2004. It appears, the RBI was oblivious of the circular flow of funds between banks and the private corporate sector (PCS), bypassing capex during 2000s. It even did not take seriously its specific study of 765 companies’ financials for FY2000-12, which shows the share of gross fixed assets declining from 74.2 per cent in FY 2003 to 52.6 per cent in FY 2012 whereas financial investment and cash and bank balances increasing from 12.4 per cent to 19.8 per cent and 4 per cent to 8 per cent, respectively (page 15, RBI’s Financial Stability Report (FSR) December 2013). .

The FSR of June 2014 finds top 10 corporates’ financial income higher than top 10 banks’ treasury income in FY 2013 — a case of corporates’ over-financialisation. Implications of these in terms of tepid manufacturing growth, muted capex and non-convergence in working of finance and businesses have not been critically analysed and acted upon.

Misinterpretation

The RBI not only missed the warning signals coming from declining capital intensity but it did not even analyse the contradictory positions — CSO data show surge in private corporate sector’s GCF (the very basis of the golden growth period), whereas its own data show a steady fall in gross fixed assets to total assets during FY2004-08 and later on.

Interestingly, the CSO’s estimation of PCS-GCF is also based on extrapolation of RBI’s corporate financial data. The contrary conclusions with the same database are because CSO’s estimation of PCS-GCF is based on flow-of-funds to PCS and not its actual uses, whereas the RBI’s data are from audited balance-sheets. They are factual.

This is clear from circular flow of funds between banks and PCS bypassing capex. Decline in uses of funds by PCS for capex was also highlighted in the Report of the High-Level Committee on Estimation of Savings & Investment, 2009.

It concludes that the share of investment in financial assets and bank deposits in total uses of funds increased respectively from average of 11.3 per cent and 2.6 per cent in 1990s to 19.2 per cent and 7.4 per cent during 2000-07; displacing mainly the share of funds used in gross fixed assets.

The 12th Plan Working Group on Estimation of Investment, its Composition and Trend, the Planning Commission also underscored the fact of decline in share of gross fixed capital. It appears, not only RBI, but other professionals were also mechanistic in interpretation of the crucial growth-impacting changes in corporates’ asset structure.

Why circular flow?

Corporates borrow funds for capex/working capital. However, unequal/stiff competition from massive Chinese import (CAGR of 58 per cent in dollar terms during FY 2004-08) and arbitrage opportunity arising from large sub-PLR lending by banks in 2000s and high-interest bearing bulk deposits encouraged large circular flow of funds between banks and PCS.

It bypassed capex. This is clear from the fact that PCS’s fixed deposits with banks increased with a CAGR of 48 per cent (39.5 per cent during 2000s) and sub-PLR lending had reached as high as 76 per cent of total credit during 2004-08.

Systemic factors

A combination of factors, which include removal of quantitative restrictions on consumer goods in 2001, decline in weighted average basic import duty rates (22 per cent in FY 2003 to 9 per cent in FY 2008), steady appreciation of the rupee (annual average ₹48.4/$ in FY 2003 to ₹40.2/$ in FY 2008), circular flow of funds between banks and corporate sector, and China’s aggressive export policy aided by corrupt import practices are having ruinous effects on the industrial economy.

Even official imports from China increased with a CAGR of 25 per cent during FY2003-18. Imports were in the nature of products in final/CKD form, rather than of components in production. Manufacturing in many industries like electronics have turned simply into assembling units. Information failure in terms of price, quantity, quality of many Chinese imports create cost-price uncertainty for indigenous manufacturers to undertake production/capex.

Severe damage has been caused to the manufacturing base, employment, productivity, trade competitiveness, skill and technological development. Manufacturing IIP growth at 3-4 per cent for the last 7-8 years is dismal despite growth-boosting policies like New Manufacturing Policy, 2011, Make in India, etc.

Green-field manufacturing projects are few and far between. Manufacturing exports’ share declined from 80 per cent in FY 2000 to 61 per cent in FY 2011. The India Growth Story potential has not been realised despite strong fundamentals and big ticket policy reforms.

Meanwhile, the deluge of Chinese goods contributed to widespread industrial sickness. Number of CDR references spurted from 225 to 622 during FY 2010-14 with corresponding aggregate debt spurting from ₹95815 crore to ₹429989 crore. Deterioration in trade competitiveness has led to high trade deficit. Non-oil trade surplus of $6.4 billion in FY 2003 rapidly turned into massive deficit of $37 billion by FY 2008 and to $91 billion in FY 2018.

Big Data analytics needs to be used to bring these aspects to the forefront. The writer is a former DGM of SIDBI.

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