Commentary

Services Won’t Save Us from Recession

The global recession is going to be worse than expected. The developed countries as a whole will suffer a fall in GDP in 2009, the first fall since World War II. India cannot escape the global downswing. But the mid-term review of the economy, presented recently to Parliament, claimed that India would prove more resilient than some other countries. Why?

Because India had an exceptionally large services sector, which would suffer least in a downswing. Sorry, but that’s not really the case. As the accompanying table shows, India does not have a particularly large services sector. According to the World Development Indicators 2007, World Bank, the share of services in GDP is only 53% in India, against the global average of 69%, and 59% in all low/middle income countries.

The share is 58% in Sri Lanka, 54% in Pakistan and 53% in Bangladesh. So, India is a services laggard even in South Asia, not a leader!

What about other developing countries? China has by far the lowest share of services in GDP, only 40%. This is largely because of the dominance of its industry, which accounts for 48% of GDP, against 29% in India and 28% globally. It may also represent undercounting of services in a country that, under Communist rule, collected data only on Gross Material Product, ignoring services altogether.

India is a laggard among prominent developing countries. The services/GDP share is 66% in South Africa, 64% in Brazil, and 57% in Russia. Even Kenya, which remains highly agricultural, has a 58% ratio. Some backward African economies have a lower share of services than India. But, by global standards, India’s services share is actually low, not high. That makes India more vulnerable than others to a global downswing, not less so.

What accounts for the widespread impression that India is a services powerhouse? Well, IT services have made India world famous for computer software, business process outsourcing and knowledge process outsourcing. IT service exports have grown from almost nothing to $40 billion last year, a fantastic achievement.

Yet IT services hardly figure in the national accounts. This is partly undercounting: we have not adjusted sector weights to reflect the runaway growth of the IT sector. It also reflects the fact that half of our supposed software exports represent onsite work done in the importing countries. These are counted in the GDP of the importing countries, not India.

The standard break-up of services in CSO accounts lists four main categories: trade and hotels; transport and communications; finance, real estate and housing; and community services (including all government services). Presumably various IT services are distributed within these categories.

The Economic Survey shows that in the 10th Plan period (2002-07), trade and hotels averaged annual growth of 8.5%, transport and communications 15.3%, finance and real estate 9.5%, and community services 6.1%. The first three service categories grew distinctly faster than GDP (7.8%), showing how important services dynamism is for India. But services dynamism is common the world over, so India does not stand out.

Will all service sectors really be resilient in the face of a global slowdown? Some yes, others no. Trade is clearly going to be hit. Exports have declined by 10% and 12% respectively in October and November. The slowdown will reduce imports too in 2009. Industrial production will decelerate, affecting domestic trade. Hotel occupation and tourism will take a hit in a slowdown. So this category — trade and hotels — will not be resilient in a recession.

Transport and communications show a mixed picture. Transport is definitely slowing down: commercial vehicle sales have halved in the last two months. The first half of the current fiscal year looked fairly good in terms of port and rail traffic. But the economy fell off a cliff in October, so future months will look bad.

Happily, telecom continues to forge ahead, regardless. The additional of monthly telecom connections now exceed 10 million, against eight million a year ago. Rural transmission towers are expanding fast and boosting rural telephony. And the coming 3G auctions may spawn a new, dynamic form of telephony.

This sector will be a boon to GDP growth in 2009. Finance and real estate also present a mixed picture. Banks are fearful of bad debts, but overall bank lending will surely grow at a good pace, aided by huge government bond issues, loose monetary policy, interest rate cuts and lower CRR requirements. However, non-banking finance is under pressure, while real estate and stock market-related activities are in dire straits.

Community services will be boosted by full implementation of the Pay Commission award. In our statistics, we count the pay of government servants as value added, even though the sector subtracts value through bribes, inefficiencies, delays and absenteeism. This overvaluation of government services may offset the undercounting of IT services.

In sum, communications and community services will be resilient in the downturn, but trade, hotels, finance, real estate, transport and the IT sector will grow more slowly than before, sometimes markedly so. The deceleration will be less dramatic than for industry, but will not save GDP from taking a nasty hit.

Ironically, the sector that has really shielded us from the global downturn so far is agriculture, not services. Agricultural growth in recent years has averaged almost 4% per year, double its ninth Plan rate. Agriculture is largely insulated from the global economy by trade barriers and price controls. However, after several good monsoons in a row, the chances of a bad monsoon in the coming year must be high. Cynics will call fast agricultural growth a weather-induced bubble, ripe for bursting.

So, gird your loins for tough times ahead. Our services sector is not large by international standards, and parts of it will be hard hit by the recession. Only some services will remain resilient. Let us not be over-dazzled by our IT success, and let us avoid the illusion that services will insulate us from the global slowdown.

Swaminathan S. Anklesaria Aiyar is a research fellow at the Cato Institute’s Center for Global Liberty and Prosperity.