Service Sector Contribution to India’s GDP Growth *

1. Introduction

The growth of India’s GDP, especially after the 1990s, was greatly influenced by the opening-up of the economy. This paradigm shift in Indian economy occurred in the wake of balance-of-payments crisis of the 1991. The Government of India opened up Indian markets to facilitate entry of private foreign investments into the Indian markets. This change in Indian economic policy, from a highly insulated market to an open market facilitated inflow of foreign direct investment (FDI) and portfolio investments by foreign institutional investors (FIIs). While the growth rate picked up from early 1980’s onwards, in the recent past, i.e., from the financial year 2003-04 onwards the growth of GDP at factor cost reflected a level jump from about 6.5% to 8.5 to 9%. This significant rise was mainly due to rise in services and manufacturing activities. After posting a higher growth for five years, GDP growth rate for the fiscal year 2008-09 witnessed a lower growth of 6.7%, on the backdrop of global crisis. The growth rate is expected to remain at the same level in 2009-10, but is predicted to regain after 2010-11. This note attempts to trace the pattern of sectoral growth and the increasing share of services sector since the reform period.

2. Gross Domestic Product – Sectoral Growth Pattern

Though the average annual growth rate of agriculture sector had never been very high, as compared to industrial and services sectors over the decades, agricultural sector has managed to maintain its average growth of about 3.4% for the period 2001-02 to 2007-08, against a growth of 3.1% in 1950-51 to 1960-61. In the interregnum, after registering a lowest average growth of 1.8% during the period 1971-72 to 1980-81, agriculture and allied activities posted a growth of 3.5% for the period 1981-82 to 1990-91. The period 1981-82 to 1990-91 represented a structural break, as during this phase, the total GDP of the economy reached a higher growth trajectory of 6.2% from its earlier Hindu growth rate of about 3.5-4.0 %.  From this period onward, significant growth has been witnessed in both services and industrial sectors.  The average annual growth in industrial sector showed a cyclical pattern. After slowing down from 6.3% in 1950s, to 4.0% in 1970s, it gained momentum in 1980’s to 6.2%, but the 1990s witnessed a dip to 5.6%. The current decade saw the highest average annual growth of 8.1%. The services sector showed consistent improvements since 1950s but for a dip during 1970s and the current decade represents really an accelerating trend in services sector growth. (Chart A). 

The decadal growth pattern across sectors is reflected in the changing share of different sectors in national GDP. From a peak of 53.3% in 1950-51 to 60-61 the share of agricultural sector came down to 20.5% for the period 2001-02 to 2007-08. Slow down in its share started reflecting during the period 1981-82 to 90-91 when industries and services sectors gained speed. Thereafter, while the manufacturing sector has been posting a higher growth, the share of services sector started rising tremendously and contributed the most to GDP growth rate (Chart B).

3. Causes for lower Contribution from Agricultural Sector  

Some of the major factors contributing to low growth and contribution to GDP by the agriculture sectors are:

•       The agricultural sector has shown a lower performance due to a number of factors such as illiteracy, insufficient finance, insufficient irrigation facilities and inadequate marketing of agricultural products.

•       The average size of the farms is very small which in turn results in low productivity. The sector has not adopted modern technology and agricultural practices to a larger extent.

•     According to World Bank's "India: Priorities for Agriculture and Rural Development", India's large agricultural subsidies are hampering productivity-enhancing investment.

•     Over-regulation of agriculture has increased costs, price risks and uncertainty. Government intervenes in labour, land, and credit markets, as well as inadequate infrastructure and services also contribute to slow down in growth of agricultural sector.

•       Another problem is the humanitarian aspect - the problems faced by Indian farmers, which has to be given attention separately from the attention given to the agriculture sector. And the main problem when we talk about farmers, in general is the kind of social relations of distribution that they are subject to, which essentially derive from the class structure and the local power balance. Even macro solutions like improvements in productivity etc., if achieved, cannot be all that effective in improving the lot of farmers unless ground problems like disguised unemployment, farmer helplessness & indebtedness are addressed.

4. Industrial Sector

The industrial sector is made up of manufacturing, mining and quarrying, and electricity, water supply and gas sectors. The various sectors in Indian industry are gaining more and more importance. Within the industrial sector, the major contribution is derived from the manufacturing sector. The manufacturing sector played a significant role in achieving the higher economic growth rate. Besides being a significant contributor to the GDP growth, it is the second largest employment provider to the country’s skilled as well as unskilled labour force and a major contributor to export.

There has been moderation in growth rate of industrial sector for the year 2007-08. The performance of the manufacturing sector increased steadily from a negative growth of 2.4% in 1991-92 to 11.8% in 2006-07. Mining and quarrying has registered a higher growth of 8.8% in 2006-07 as against 3.4% in 1991-92. The growth in electricity, gas and water supply has witnessed a lower growth in 5.3% in 2006-07 as against a higher growth of 9.7% in 1991-92. Whereas, for the year 2008-09, industrial sector saw its major slow down as this sector was badly affected by global crisis.

 The rebound in the industrial sector in conjunction with the services sector has powered India’s GDP growth since 2003-04 and has led to build up of optimism of targeting still higher growth for the economy. The resilience shown by the industrial sector against the hardening of global oil prices is reflective of inherent strengths and capabilities that the industrial sector has built up over the years since the initiation of economic reforms in the country. Improvements in infrastructure facilities will be critical to sustain and accelerate the current industrial growth. A substantial manufacturing base is essential to absorb the workforce and ensure sustainable growth of the economy. Apart from improvements in physical and social infrastructure, this would, inter alia, require imparting requisite skills to the labour. Furthermore, the Indian industry needs to step up research and development expenditure to improve its competitiveness in the global economy to move up the value chain and to strengthen its position in skill intensive industries.

5. Services Sector

The main thrust in recent years to GDP growth has come from the services sector. Services contribute currently to about 56.0% of the GDP. Rapidly, the quality and complexity of the type of services being marketed is on the rise to match worldwide standards. Whether it is financial services, software services or accounting services, this sector is highly professional and provides a major impetus to the economy.

IMF Working Paper, “Understanding India’s Services Revolution” prepared by James Gordon and Poonam Gupta in September 2004 had explored the factors behind the dynamism of the services sector in India. One explanation suggested that income elasticity of demand for services is greater than one. Hence, the final demand for services grows faster than the demand for goods and commodities as income rises, which results in fast growth of services. Another explanation is that technical and structural changes in an economy make it more efficient to contract out business operations, which are done internally by individual firms. This type of outsourcing has been called the “splintering” of industrial activity. Splintering result in an increase in net input demand for services from the industrial sector, and in turn, the services sector grows proportionately faster than other sectors. They suggested that there is considerable scope for further rapid growth in India’s service economy, as Indian services exports have strong future growth prospects, but also found that there is considerable scope for further rapid growth in other segments provided that deregulation of the services sector continues. Nevertheless, it is imperative that the industrial and agricultural sectors also grow rapidly. The relatively jobless nature of growth in India’s services sector further underscores this need.

Following the trade liberalization in 1991, the Indian economy embarked on a path of rapid growth of aggregate output. In particular, it witnessed a high growth rate of service sector output while that of industry was relatively muted. As a result, the share of services in GDP has come to resemble that of a high income country while its per capita income still remains that of a low income country.

The service sector accounts for more than half of India's GDP, this sector has gained at the expense of both the agricultural and industrial sectors through the 1990s. The rise in the service sector's share in GDP marks a structural shift in the Indian economy and takes it closer to the fundamentals of a developed economy. In the developed economies, the industrial and service sectors contribute a major share in GDP while agriculture accounts for a relatively lower share. Services sector includes trade, hotels and restaurants, transport storage and communication, financing, insurance, real estate and business services. The contribution of each sub-sector of services has been shown in (Table 2).

Within it, the share of transport, storage and communication as well as community services has increased over the period. The fact that the service sector accounts for more than half the GDP probably marks a structural break in the evolution of the Indian economy. (Chart C).

India is fast becoming a major force in the Information Technology sector. According to the National Association of Software and Service Companies (NASSCOM), over 185 Fortune 500 companies use Indian software services. The world's software giants such as Microsoft, Hughes and Computer Associates who have made substantial investments in India are increasingly tapping this potential. A number of multi-nationals have leveraged the relative cost advantage and highly skilled manpower base available in India, and have established shared services and call centers in India to cater to their worldwide needs.

When one does a deep dive into the services sector one finds that 80% of employment is within construction and informal trade and the rest is divided between IT and Information Technology Enabled Service (IteS), retail, etc.

This point elucidates the breadth and impact of the services sector that through IT and ITeS has showcased India’s technology skills to the world and also highlights the employment capability within this sector. Among the people working in the services sector, 90% do not have basic elementary education and 30-40% are completely illiterate. IT and ITeS have the highest bar on quality. For instance, technical employees in the IT sector require an engineering degree whereas just one of 500 in the retail sector requires the equivalent managerial skills. The services sector is expected to contribute to over 70% of the economic growth in India over the next five years, and 60% of new jobs over the next five years is to be generated by services.

Civil Aviation in India has developed rapidly in recent years. The rapid rate of expansion has been possible due to its relatively modest starting point, however, further growth will require massive investment in infrastructure, redesigning airspace and improving the overall air traffic management system, together with changes in procedures, while maintaining strict adherence to the international standards of safety and security. The sector had been growing at an annual rate of up to 25.2%. In 2007 the Civil Aviation Sector in the country has witnessed a boom as the domestic passenger carriage, cargo movement and international air traffic had shown an exponential growth. This growth has been largely due to policy of increased liberalization both on domestic and international sectors. Domestic passenger traffic increased to 43.3 million in 2007, which was an increase of 36.7% compared to 2006. (Ministry of Civil Aviation 2007).

Within the automobile sector, automobile production trend reflects that the number of vehicles has gone up from 6.3 million in 2002-03 to 11.2 million in 2008-09. The automobile sector has been contributing its share to the shining economic performance of India in the recent years. With the growing middle class with higher per capita income, the demand for private vehicles including cars and two-wheelers has picked up. Product movements and manned services have boosted the sales of medium and sized commercial vehicles for passenger and goods transport. Though the industry has been witnessing an impressive growth during previous years, the performance after 2006-07 has not been encouraging. The automobile sector recorded a growth of 13.6% in 2006-07. In 2007-08, the industry registered a negative growth rate of 2.3%. However, in 2008-09, the industry has witnessed a modest growth of 3.0%. While passenger vehicle, two-wheeler and three-wheeler registered a growth of 3.4%, 4.9% and 0.1% respectively; the utility vehicles and commercial vehicles segment registered a negative growth of 11.9% and 24.0% respectively. (Economic Survey 2008-09).

Tourism is the largest service industry in India, with a contribution of 6.2% to GDP and providing 8. 8% of the total employment in India. India witnesses more than 527 million domestic tourism visits. The tourism industry in India generated about US $100 billion in 2008. The Ministry of Tourism is the nodal agency for the development and promotion of tourism in India. It maintains the "Incredible India" campaign.

According to World Travel and Tourism Council, India will be the world's leading tourism hotspot, having the highest 10-year growth potential. The Travel & Tourism Competitiveness Report 2007 ranked tourism in India 6th in terms of price competitiveness and 39th in terms of safety and security.

India has a growing medical tourism sector. The 2010 Commonwealth Games in Delhi are expected to significantly boost tourism in India. The number of foreign tourist arriving in India up to 2006 has almost gone up thrice over the years (Chart D).

5.1 Further Expectations from Services Sector

Though India is emerging gradually as a center of excellence in some specified service industries such as software, biotech, healthcare, and higher or technical education, there is a need to evolve robust quality systems and effective delivery mechanisms to be on par with the best in the world. The literacy rate from 45.0% in 1991 has reached to 61.0% in 2004 in rural areas, whereas, in urban areas it has posted a rise to 82.0% in 2004 against 73.0% in 1991. (Chart E).

If the service sector has to drive the GDP growth rate and increase its share to the world average of 60-65%, its vertical segments have to tap the global market aggressively, taking advantage of the low-cost operations, wealth of talent pool, and the domain knowledge of these emerging technologies.

The Indian IT industry, especially its software services sector has shown the way by its path-breaking dominance of the global technology market. Apart from driving employment generation, the service sector will be able to play a dominant role in activating the infrastructure and industrial sectors, as they are inter-dependant for the uniform growth of the economy.

Agriculture’s contribution to the economy has been steadily declining from 1957-58 when it formed 51.2% of India’s GDP to 31.7% in 1987-88 and 17.8% in 2007-08. Services sector has increased from 30.9% in 1957-58 to 43.0% in 1987-88 and currently form about 55.7% of the GDP. As this transition from an agrarian to services focus is taking place, one can make a thought as how the two sectors could be optimised while leveraging the others’ resources. As of 2007, 273 million people were part of the agricultural workforce but there is a surplus of approximately 62 million workers in agriculture. If the excess 62 million workers could be absorbed by the services sector which in 2007 had 150 million employed, “even at the average productivity of services, their earnings would be more than in agriculture and in the process India’s GDP could rise by about 25%.” Agriculture while contributing $174 billion to India’s GDP employs a workforce of 273 million, whereas services contribute $500 billion but its workforce stands at 150 million.

The services sector in the country has benefited from the availability of vast skilled labour. Furthermore, the growing knowledge-intensive services activities will require human resources equipped with appropriate skills. Hence, enhancement of skills of human resources at all levels, especially at higher levels of education, requires greater priority. In particular, demand for tertiary education is expected to increase significantly in the coming years. A renewed focus on developing high quality institutions of learning at all levels will be essential for India to benefit from its demographic advantage.

5.2 Limitations

While output generation has shifted to services, employment creation in services has lagged far behind. India’s relatively jobless service sector growth is unlike the experience of other countries, where the service sector has also tended to gain a larger share of employment over time, (Table 3).

The later Working Paper of IMF, “India’s Pattern of Development: What Happened, What Follows?” prepared by Kalpana Kochhar, Utsav Kumar, Raghuram Rajan, Arvind Subramanian, and Ioannis Tokatlidis in January 2006, indicated that though services in the aggregate has grown in all states, there seems to have been a noteworthy difference between services that are predominantly in the public sector and those that are in the private sector. The share of public sector services such as electricity, public administration, railways, and other community services is growing in the laggard states, while the share of private sector services such as business services (including software), real estate, and retail trade is growing in the fast-moving states. The important conclusion that emerges from analyzing the performance of the Indian states is that since 1980, despite the liberalization policies, India is actually veering further away from labor-intensive industries. Furthermore, there is no clear pattern of movement amongst fast-growing states towards these industries-instead, they seem to be moving into skill-intensive services.

The share of the service sector in GDP has increased steadily over the years. But now, the structural change in the capital formation in favour of industry will probably help to raise the industry’s share too. The improvement in demand conditions and a sharp top line growth during the few years have led to a dramatic rise in industrial investment. Corporate India has gone on to increase production capacity to meet the growing demand.

This is reflected in the changing pattern of fixed capital formation. The gross fixed capital formation in terms of industrial machinery and equipment in public, private and household sector over total gross fixed capital formation has increased by 7.7%, 29.5% and 9.3% respectively during 2007-08 as against a 15.4% rise in the aggregate fixed capital formation.

Higher share of the service income in GDP may indicate prosperity, but the growth in earnings from trade, hotels and restaurants or for that matter from financing, insurance, real estate and business cannot be sustained unless industrial income grows proportionately to support their prosperity.

Sectors like financial, healthcare and education have been in the public sector domain over the decades, driven by institutional or budgetary support, the huge fiscal deficit, interest burden, and international commitments have dried up government resources to expand the sector to meet the growing needs of a billion population.

6. Summing Up

The service sector is clearly emerging as the new engine of economic growth. The sector needs to be geared up for improving the quality of life and play a greater role in the economic development.

* This note has been prepared by Ms Shruti J. Pandey

References

Various Media Sources

IMF Working Paper, “Understanding India’s Services Revolution” (September 2004)

IMF Working Paper, India’s Pattern of Development: What Happened, What Follows?” (January 2006)

Ministry of Civil Aviation Government of India, Year End Review 2007.

Society of Indian Automobile Manufacturers (SIAM)

Government of India (GOI) Economic Survey 2008-09

Central Statistical Organisation (CSO), National Accounts Statistics 2009, www.mospi.nic.in

Central Statistical Organisation, Statistical Abstract India 2007