Indian growth: Pro-business or pro-market?

Ashoka Mody, Anusha Nath, Michael Walton

20 November 2011



A debate exists on whether Indian policy changes and growth accelerations of the past 25 years are best interpreted as a move toward a “pro-business” orientation (see for example Rodrik and Subramanian 2004 and Kohli 2006) or a “pro-market” position (see for instance Panagariya 2008). Under the pro-business view, the government granted favours to the large-scale private sector, which unleashed investment and growth but has essentially led to “oligarchic” capitalism. By contrast, the pro-market perspective views the mix of reduced restrictions and external liberalisation as the main driver of changes in economic performance, working via heightened competitive pressures on firm behaviour. To inform this debate, we analyse the correlates of profitability of firms listed on the Bombay Stock Exchange, covering a dynamic period in terms of firm entry and growth, from the early 1990s to the late 2000s.

The core econometric analysis relates a firm’s profit rate to its profit rate in the preceding year, other firm characteristics, key features of the industry in which the firm operates, and macroeconomic conditions. The results indicate that the Indian corporate sector is “normal,” in as much as the dynamic relationship we estimate resembles in many respects that for firms in industrialised countries (Goddard et al. 2005 and Tregenna 2009).

Figure 1 helps motivate our main results. The profit rate of firms – as measured by the ratio of profits before interest and taxes to assets – of our sample of Prowess firms, all of whom are listed on the Bombay Stock Exchange (BSE), fell from 1993 to around 2002, and then rose through 2007. Apart from the early years, the profit rate moved rather closely with the Indian GDP growth rate. In the early years of our sample, firms may have been able to exploit the relatively high inflationary environment to raise prices faster than costs.

High profitability may also have been part of the heritage of the license and protection regime. But, thereafter, the link to short-run demand pressures diminishes and the link to GDP growth strengthens. Thus, through 2002, slow GDP growth and substantial entry of domestic firms and opening to foreign competition appears to have depressed profitability. By about 2001, market shares stabilised and GDP growth started increasing, which was reflected in the rise in the profit rate. Thus, growth, investment, and profitability appear to have reinforced each other.

Figure 1. The rate of corporate profits and growth rate of GDP, 1993-2007

Note: ROA refers to the ratio of profits before interest and taxes to assets for the sample of firms in the Bombay Stock Exchange.
Source: CMIE, Central Statistical Organisation

More extended results support the presence of competitive tendencies (Table 1). These and other results are reported in Mody, Nath, and Walton (2011).

Table 1. Correlates of corporate profitability: Base regressions, annual data, 1993-2007

Note: Robust t-statistics in brackets *** p<0.01, ** p<0.05, * p<0.1
Sources: Authors calculations from data reported in CMIE. “Overheating” and “economic growth” are principal components, the former mainly reflecting high inflation and interest rates, and an appreciated real exchange rate) and the latter mainly reflecting GDP growth and a benign global financial environment.

The main results from Table 1 can be summarised as:

  • Profitability persists from year to year. But the persistence declines when profitability is averaged over longer periods (up to four years), suggesting some “super normal” profits are whittled away over time. More efficient firms tend to have more persistent profits. Thus, some part of the persistence reflects greater efficiency, although because of the overlap between efficient and large firms, market power may also have a role in maintaining the profit rate over time.
  • There is no consistent evidence of a general influence of market concentration on profitability. If anything, firms in less concentrated sectors have higher profit rates.
  • Firms with growing market shares do enjoy higher profitability, but the pattern of results is more consistent with the success of dynamism – in particular, this finding is equally or more true of small firms and less concentrated industries.

We interpret the findings to reveal a mixed, but largely positive, story for corporate expansion following economic liberalisation in the late 1980s and early 1990s. The corporate economy represented by the BSE firms looks more like an exemplar of dynamic, competitive capitalism than of concentrated market power and economic entrenchment, at least with respect to product markets. This is in spite of concerns raised by other authors over the continued importance of public sector ownership and of the business house organisational form – including specific evidence of tunnelling in business houses. Problems of incentives and behaviour in the public sector and in pyramidal groups may well exist, but there is no evidence that it is driving overall patterns of profitability.

In particular, firms are not able to maintain high profit rates even over three or four years. And where profits do persist, they are in significant measure associated with relative efficiency. While our analysis does indeed provide support for a robust, consistent relationship between increases in firm-level profitability and market shares, this is more a sign of dynamism than entrenchment. The fact that this relationship is similar for free-standing firms as well as established business houses, and for small as well as large firms, suggests that it is driven by the effect of better underlying firm performance, as opposed to the exertion of market power. There is no evidence of a profitability-increasing influence of measured industrial concentration, though we may be mismeasuring concentration by basing it only on firms in our BSE database.

That said, after a period of substantial entry into the group of formal, listed companies in the 1990s, there was only limited new entry in the early 2000s, although it recovered somewhat later in the decade. The tendency towards reduced concentration prior to 2000 appears to have reversed thereafter, with a small increase in concentration recently. Along with that, there emerged some evidence of significant high-end profitability (Figure 2).

Figure 2. The changing distribution of profitability across firms, 1993-2007

Source: CMIE

In addition, those with opposing views can, with justification, argue that our analysis does not cover influences, such as corporate governance and state-corporate relations, which may paint a less flattering picture of the corporate sector’s role. While we infer that profit persistence mainly reflected firms’ efficiency, some part of the persistence may have been due to imperfections in domains outside product market structure. Good candidates for such imperfections lie in the markets for corporate control, finance, and the management of talent. An econometric study such as this cannot identify state-corporate links between key firms and players that may have been influential in shaping profits.

Thus, while this paper has positive news on capitalism in India, it does not imply that all is well. The striking dynamism in corporate profits and asset formation in this period contrasts with a surely slower pace of change in the functioning of the state. How these differential speeds will eventually interact may well fashion the next phase of corporate evolution in India. Those broader themes deserve further attention.

Authors’ note: The views expressed here are those of the authors and not necessarily those of the IMF, its management, or its Executive Board.


Goddard, John, Manouche Tavakoli and John OS Wilson (2005), “Determinants of profitability in European manufacturing and services: evidence from a dynamic panel model”, Applied Financial Economics, 15:1269-1282.

Kohli, Atul (2006), “Politics of Economic Growth in India, 1980-2005”, Economic and Political Weekly, 41(13):1251-1259, and 41(14):1361-1370.

Mody, Ashoka, Anusha Nath, and Michael Walton (2011), “Sources of Corporate Profits in India: Business Dynamism or Advantages of Entrenchment?”, India Policy Forum 2010-11, Sage Publications.

Panagariya, Arvind (2008), India: The Emerging Giant, Oxford University Press.

Rodrik, Dani and Arvind Subramanian (2004), “From ‘Hindu Growth’ to Productivity Surge: The Mystery of the Indian Growth Transition”, Working Paper WP/04/77, International Monetary Fund.

Tregenna, Fiona (2009), “The fat years: the structure and profitability of the US banking sector in the pre-crisis period”, Cambridge Journal of Economics, 33: 609-632.




Topics:  Development Macroeconomic policy Politics and economics

Tags:  growth, India

Visiting Professor in International Economic Policy at the Woodrow Wilson School, Princeton University

Graduate student, Boston University

Lecturer in International Development at the Harvard Kennedy School