POTENTIAL OBSTACLES TO SUSTAINABLE GROWTH DIMINISHING RETURNS TO CAPITAL INVESTMENT Diminishing returns to capital investment in emerging economies such

as China, as has occurred in the past for Japan. This will play a major role particularly if methods of allocating capital are not improved in emerging economies like China and India, where state banks continue to play a dominant role. INDIA India's economy grew below five per cent for the fourth quarter in a row during the JulySeptember period of FY14, even as the gross fixed capital formation (GFCF) rate, a proxy for investment, hovered around 30 per cent of gross domestic product (GDP). Such a level of GFCF is enough to yield a growth rate of seven per cent. It is interesting to note that despite high interest rates and low demand, GFCF has been holding on at about 30 per cent for the past few years. GDP rose 4.8 per cent in the second quarter of the current financial year, while GFCF stood at 29.4 per cent of GDP. Such a dismal growth of the economy is basically due to rising incremental capital output ratio (ICOR). This means, the capital invested is not yielding the desired output. Had capital output ratio been four, 29.4 per cent of GFCF would have produced a GDP growth of 7.3 per cent. However, ICOR rose to 6.1 in the second quarter of FY14 from 3.2 in 2006-07. During 2006-07, GFCF at 31.3 per cent of GDP had produced an economic growth rate of 9.6 per cent. This means that while GFCF rate declined 1.9 percentage points, economic growth rate halved between 2006-07 and the second quarter of 2013-14. ICOR has been rising due to inefficiency in the economy because of which projects are either stuck or there is imbalance between various investments. "It is because of imbalance in capital creation. One example is power and coal imbalances The Cabinet Committee on Investments (CCI) was set up earlier this year to clear the stuck up projects. It has so far cleared projects costing over Rs 3 lakh crore. The CCI has so far cleared projects relating to power, oil, and road among others. CHINA Compared to the rest of the world, Chinas investment efficiency was about as good as it gets. At 3.4, Chinas ICOR was lower than all other countries, save for Singapore. Indonesia and Taiwan had ICORs over 4. Thailands was 5. On this 5 year time frame when global resources were fully employed Chinas investment was 85% more efficient than the USs, twice as efficient as Koreas and nearly 4x more efficient than Japans. Sadly, Chinas ICOR has risen markedly since 2007. It now stands at 4.7. Over the past four years, investment efficiency has fallen by nearly 40%.

Actually, it means nothing of the sort. ICORs the world over soared when then global financial crisis hit in 2008. Taiwans ICOR jumped to 30. Koreas jumped to 98. Singapores rose to 13 in 2008 and then plunged to -30 in 2009 as growth turned negative. The US ICOR dropped to -49 in 2008; Japans dropped to -22.

Longer-term ICORs Where does this leave us then? What do Chinas ICORs look like from a l onger-term perspective? They look pretty good, and not much different from other Asian countries that came before China in the development processes. As one would expect, investment has become less efficient over time but over decades, not over small periods of 5-10 years. In 2011, investment efficiency is ever so slightly above trend but, for reasons noted above, nothing can be inferred from that about Chinas long-run growth rate. Given the historical volatility and the global financial crisis, the 2011 reading is nothing but a blip. From a longerterm perspective, does China look different from other Asian countries that went through their rapid development phases in the 60s and 70s and 80s? Not really.

It had been argued that China invests too much and it needs to rebalance its economy by investing less and consuming more. Otherwise, diminishing returns on capital will cramp future growth; or, worse still, massive overcapacity will cause a slump in investment, bringing the economy crashing down. The table below shows the Capital Investment as a percentage of GDP for various countries. Country China Sri Lanka India Australia Kenya Russian Federation Ghana Brazil Germany Portugal Cote d'Ivoire United Kingdom 1990 25.9 21.9 23.8 27.3 20.6 28.7 14.4 20.7 22.8 26.5 8.5 20.5 2000 34.1 28.0 22.8 25.6 16.7 16.9 23.1 16.8 21.5 27.7 11.2 17.1 2011 44.4 34.6 29.5 27.1 24.3 23.1 21.8 19.3 18.2 18.1 16.4 14.3

A SLOWDOWN IN THE RATE OF PROGRESS AT THE TECHNOLOGICAL FRONTIER It is possible that measured GDP growth could slow down due to difficulties in measuring technology-related improvements in the quality of some services. IDC (International data Corporation) forecasts that in 2014, a rebound in China and continued momentum in the US and Europe will see a return to overall IT industry growth of more than 5% (reaching $2.14 trillion). Technology researcher Gartner Inc. said that spending on information technology (IT) is set to rise steadily in India in 2014 despite tough macroeconomic conditions, giving Indian software companies hopes of a share in a market that has been dominated by their larger multinational rivals. Gartner forecast IT spending in India will rise by at least 6% to $71.3 billion in 2014, with most of the growth driven by spending on IT services. Gartner said the telecommunications services market would continue to be the biggest IT segment in India with spending expected to touch $30 billion in 2014, a marginal increase from $29.2 billion this year. Spending on devices, including mobile phones, tablets and printers, is expected to rise 6% to $30 billion in 2014. The devices segment is expected to become the largest IT spending sector by 2017. Indias $108 billion IT industry is the third largest among emerging economies and the fourth-largest among mature Asia-Pacific economies.

US Market Is Resilient, Despite Politics While the US is on course to post IT spending growth of 5% this year, this translates into just 3% excluding mobile phones. Enterprise spending in the US has been relatively resilient, given the on-going political volatility, but spending on PCs and servers will decline this year while storage investment is flat. Both the storage and server markets in the US are expected to improve in 2014, but PC spending is likely to remain weak in spite of signs of stability in Q3 as tablet cannibalization continues at lower price points. The US market has held up pretty well, all things considered, said Minton. The main headwind, aside from uncertainty over the next round of political dogfighting, is cannibalization as tablets continue to eat into PC sales and as the Cloud eats into traditional IT services revenues. This cannibalization trend is seen across all geographies, and will be a constraint on IT spending even while the macroeconomic environment improves. Europe and Japan Have Stabilized Market conditions are gradually improving in Western Europe, where overall IT spending is on course for growth of 2% this year (1% excluding phones), and where economic momentum has taken a turn for the better in many countries. We assume that this gradual recovery will continue next year, translating into IT spending growth of 3% driven mainly by strengthening sales of commercial software. This year has also seen a moderate improvement in Japan, driven by the governments short-term policy initiatives; while IT spending is on course to be flat in 2013 (0% growth), this marks an improvement from our previous forecast of a 1% decline. China Will Rebound in 2014 IDC forecasts that IT demand will accelerate in China next year, in line with our expectation that macroeconomic growth and business confidence will improve. In China, overall IT spending is on course to increase by just 8% this year, the weakest pace of growth since 2008; next year, we forecast an acceleration of growth to 14% led by strengthening sales of PCs, servers, storage, software and IT services. Growth in India will remain broadly strong, driven mainly by smartphones and tablets, but we expect a slowdown in PC sales after statelevel government initiatives helped to drive strong growth in 2013, while there are also signs of weakening growth in other sectors. A gradual deceleration in tech spending is also emerging in Brazil, while in Russia the economic slowdown has driven overall industry growth to just 1% this year (from 15% in 2012). It is forecasted to 10% growth next year, driven by smartphones, software and services.