over time. The product life-cycle was very long, which necessitated reduced investment.
Low competition gave high profitability and thus significant internal resources; the pres-
sures of facing financial markets that is caused by external financing requirements were
subdued. Most projects were profitable, and the bottleneck lay in getting support from the
government in terms of licensing. Since most projects were profitable, high leverage was
advantageous, and firms also competed in the political process of accessing debt finance in
an environment where government controlled banking. Finally, in the old world, a substan-
tial scale of investment took place in the public sector, where bureacratic processes rather
than forward-looking decision making controlled the flow of investment. This enhanced
the stability in investment.
There has been a sea change in the environment of firms. Investment by the public sector
based on five year plans has subsided. Entry barriers have been largely eliminated, so firms
now engage in forward looking decisions about investment. With low trade barriers and
foreign firms operating in India, Indian firms are now operating in the much more dynamic
global market. Investment decisions are now qualitatively different from the past. The
environment is now one of short product cycles, technological complexity, and investment
opportunities all over the world. With high competition, many projects are unprofitable.
Profits are uncertain, and expectations about profit drive investment decisions, as is the
case with firms in all mature market economies. With greater uncertainty, there is a greater
requirement for equity capital. Firms have access to a strong equity market, which (in turn)
is discriminating in the industries and management teams which get attractive valuations.
In this environment, the investment by firms is highly variable, reflecting changing
conditions in domestic, global and financial markets. This is a sea change when compared
with the stability of investment in previous decades.
Finally, the sheer size of the large firms has grown significantly when compared with
GDP, to a point where fluctuations in the investment and inventory of firms are important
on a GDP scale.
Figure 2 shows the time-series of private corporate gross capital formation (GCF),
expressed as percent to GDP. In preceding decades, this number was small - below 6% of
GDP. The decline from a good year to a bad year was perhaps two percentage points of
GDP, and this was hence relatively un-important on the scale of macroeconomics.
In recent years, we have seen the emergence of the behaviour found in the conventional
business cycle. In the investment boom of the mid-1990s, private corporate GCF rose from
5% of GDP in 1990-91 to 11.4% of GDP in 1995-96. This then fell dramatically in the
business cycle downturn to 5.9% in 2001-02, and has since recovered to 14.1% in 2005-06.
These fluctuations - a rise or fall of six to eight percentage points of GDP - are now large
when compared to GDP; they now influence macroeconomics. The inventory/investment
cycle of private corporations is, hence, of central interest in understanding the new ‘con-
ventional business cycle’ dynamics of India.
Figure 3 shows the quarterly time-series of the net profit margin of non-financial firms,
as seen in the CMIE database. This series only starts from Jun 1998, when quarterly
disclosures by firms began. It shows features associated with the ‘business cycle’ as it is
known in mainstream economics. It exhibits regularities at business cycle frequencies -