One of the economic highlights in recent weeks has been the auto expo in Delhi. Apart from the focus on the burgeoning passenger vehicle market, another interesting feature was the attention garnered by the goods vehicles segment. The biggest names in the auto industry are now upping the ante in the freight transport segment.

Not surprising at all. With high long-term economic growth (close to double digit) projected for emerging market economies (EMEs) such as India and China, the focus is naturally on these still relatively virgin markets for long-term business growth. (Some rough calculations we have made show that road freight transport is quite elastic or sensitive to the level of GDP growth in our country; Long term data indicate that for every 1 per cent growth in GDP, road freight increases by around 1.25 per cent).

In India's case, specifically, the attention on the road freight transport segment is more understandable. A close study of historic transport statistics shows that India decisively became a road-transport dominant economy somewhere around the early 1980s. From then on, road freight transport has convincingly held its share in the total freight moved in the country (around 65/70 per cent). The initiation and progress of the "Golden quadrilateral" roads scheme in the early 2000s and the sustained thrust on highways building since then may only help in further cementing the role of road freight transport.

(The contrast with the US scene cannot but be noted here. Look at the reasons advanced by Warren Buffett for his biggest acquisition so far; Berkshire Hathaway's acquisition of a controlling stake in Burlington Northern (one of the biggest US railroads) is fundamentally driven by the long-term criticality and profitability of the rail freight sector in the US and its better positioning relative to the road transport sector).

Long-term OK but what in the short-term?

The long-term business outlook for the road freight sector - and as a corollary the financing sector - decidedly is quite rosy in our country. But, what is the scenario in the short-term?

Here, one feels that more stable 'real' economic activity in our country could go a long way in fashioning a structurally sound road freight and transport financing sector. The biggest names in the financing industry may be able to weather the ups and downs in the underlying business environment; but what of the more numerous smaller players in the financing industry?

Policymakers have a profoundly important role to play in creating that more stable 'real' economic environment. What is needed is a policy framework which avoids boom and bust situations in the overall economy. The objective should be to produce more stable and structural trend growth in the economy.

What primarily drives road freight?

The level, composition and trajectory of 'real' industrial activity is what primarily drives road freight. High industrial output and stable trend growth in that output lay the foundations for a robust transport industry, which, in turn, enables the financing sector to remain healthy and vibrant.

One should say, in this context, that the underlying business environment in our country leaves a lot to be desired.

The Indian experience has been one of wildly fluctuating industrial activity. As the accompanying chart shows, it is impossible to detect any long-term structural trend in industrial production growth.

We did have a period of robust growth sustained for a period of some six years between 2002 and 2008 as the chart clearly shows.

The benefits of that period of sustained industrial growth, of course, were well-realised in the financing sector. Players who were able to negotiate even the difficult business environment of the earlier decade(s) were well-positioned to capitalize on the more conducive business environment of the early 2000s. The underlying demand environment was very strong given the trend rise in industrial output. The more favourable financing environment after 2000 then enabled some established players to post spectacular business growth in the period between 2000 and 2009.

Capital goods production so volatile

Fom the peak of some 11.50 per cent growth in 2006-07, industrial production slowed noticeably to the 8.5 per cent levels in 2007-08. This was the decelerating impact from the series of rate tightening and other slowdown measures initiated by the Reserve Bank of India from around 2005 itself.

2008-09, of course, saw industrial production growth plummeting to the 3 per cent level from the earlier high of around 8.5 per cent. One cannot get a better example of roller coasters than this. One year at 8.5 per cent and the next at 3 per cent!
It is important to note here that the 2008-09 performance was profoundly impacted by the global financial and economic crisis and the resultant economic slowdown.

Understood and accepted. But, from an Indian perspective, one cannot just remain complacent saying that the steep fall in industrial production growth in 2008-09 would soon correct itself once the global / macro economy stabilises.

The long-term track record in industrial production just does not support this argument. Look at that part of the chart prior to 2001 - that is, from 1994-95 to 2001. Look at how volatile the industrial production had been. It is no surprise that in the early 1990s and till the late 1990s, the business growth of the related road financing sector also was not a structurally rising trend - there were the ups and downs.

Ensure more stable real economic activity

The criticality of producing more stable 'real' economic activity cannot be gainsaid in this environment and given our track record. Producing more stable real economic activity, in turn, depends on creating more stable underlying demand conditions where businesses can plan and invest with confidence. On the contrary, boom and bust situations - where demand and production are high in a phase but collapse in a subsequent period - is a good recipe for producing weak financial systems and business confidence.

There are enough examples from the recent past which show how unstable demand conditions can affect industrial activity and ultimately result in weak financial conditions and systems. The construction industry, engineering ancillaries and textiles are clear cases in point. These industry segments undertook substantial capacity expansion from around early 2000 to cater to the projected increased demand. While the going was good for some time (see that part of the chart above between 2000 and 2008), the demand collapse later has landed a lot of these firms in trouble. Government, RBI and banks which lent to these industries have been forced to come out with debt re-structuring packages to tide over the difficult situation.

As for the immediate future, we feel that we should brace ourselves for a more volatile underlying business environment. Just look at the industrial production performance in the past 8 or 9 months in the table above - that is from April 2009 to the present. Capital goods production has been so volatile. Other segments of industrial output, though, are far less volatile.

The policy endeavour, in this environment, should be to produce more stable underlying demand conditions which will then translate into more stable real activity.