Monday, August 23, 2010

A supply-constrained Indian economy?

I had blogged earlier about the possibility that the supply-side of the Indian economy is unable to meet the galloping demand that is driving the high rates of GDP growth, and its role in stoking inflation.

Cement, steel, and electricity are arguably the three most critical inputs in most capital investment projects, and effective proxies for aggregate growth itself. It may therefore be instructive to examine the relative rates of growth in these sectors to see whether the supply is growing fast enough to keep pace with GDP growth.

First, here is a comparison of the relative rates of growth of the three sectors in China and India over the last two decades. China is adding cement capacity at the rate equivalent to India's total production. See also this excellent bubble graphic of the two countries cement production.

Chinese steel production has taken off vertically since the turn of the millennium, whereas India's has plateaued.

The same is the story with electricity sector too, with the Chinese take-off coinciding with around the turn of the century.

More worrying is what emerges from the comparison of India's GDP growth rates over the past decade-and-half with the respective growth rates in steel, cement, and electricity generation.

The growth rates in electricity has been consistently below even the real GDP growth rate, while that of the other two sectors have hovered around the real GDP growth rates. In contrast, sectoral growth rates in China has been well above its GDP growth rate. Typically, growth rates in these critical sectors should be atleast higher than the nominal GDP growth rates. The picture in steel, cement and electricity sectors are broadly representative of other input sectors.

The aforementioned graphics highlight the critical supply-side challenges faced by the Indian economy. In the absence of dramatic increases in production of critical inputs, much like what China has seen over the last decade, India's ability to sustain high rates of economic growth will be doubtful. In the circumstances, fighting inflation with monetary and other conventional demand-management policies will be akin to tilting at the windmills.

Statistics from here, here, here, and here.

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