Growth Slowdown: There is no “free stimulus”
The dip in manufacturing growth to a mere 1.2% brought the growth rate crashing down.
The slump in growth
The GDP growth rate in the first quarter of FY2018, which came in at 5.7 per cent, was a shocker. It was expected that there would be a minor recovery in the growth rate after the demonetisation-induced slump of the last quarter of FY2017.
The dip in manufacturing growth to a mere 1.2 per cent brought the growth rate crashing down. Going by the present trends, the actual growth rate for FY2018 would fall far short of RBI’s projection of 7.3 per cent and is likely to be somewhere near the lower band of Chief Economic Advisor’s growth projection of 6.75 to 7.5 per cent.
In the short term, achieving the fiscal deficit target of 3.2 percent of GDP would be challenging. Job generation, tax revenue receipts and public expenditure programmes depend on revival of growth. So the relevant questions are: Why is growth slowing down? What should be the policy response?
The boom years
Let us look at the issue from a longer time horizon. During 2003-11, India’s GDP grew by a record 8.4 percent. The Great Recession of 2008 didn’t impact India much. The Indian economy staged a V-shaped recovery after the minor dip in 2008-09. It is important to note that benign global economic environment of 2003-07 facilitated fast growth in all emerging markets. The record global growth of 4.5 per cent during this period was a rising tide lifting all boats. Sustained export growth of above 20 per cent annually aided India’s high GDP growth rate during those boom times.
The Great Recession of 2008, the European debt crisis of 2010 and 2011, the Taper Tantrums of 2013, the commodity crash of 2014 and Brexit impacted the global economy and pulled down the growth of emerging markets too. International trade slumped, impacting exports. India too was impacted. India’s growth rate for the seven-year period between 2011 and 2017 was only 6.65 per cent and worse, it is trending down.
The sharp revival in growth in India during 2009-11 was aided by unprecedented fiscal and monetary stimulus. The savage cut in interest rate by RBI and the massive fiscal stimulus including farm loan writeoffs, which aided the V-shaped recovery, leading to high level of inflation, which threatened to get entrenched. This forced RBI to tighten the monetary policy; and the government was forced to cut down on public expenditure to achieve fiscal consolidation.
Monetary tightening and fiscal consolidation impacted growth. The economy started slowing down and deficiency of demand constrained private capex. With capacity utilisation in manufacturing at around 70 per cent, private investment dried up.
The second half of FY2017 was impacted by demonetisation. The slump in first quarter 2017-18 growth was mainly caused by the dip in manufacturing growth to 1.2 per cent. This was largely due to the destocking impact triggered by GST.
Destocking by traders led to poor orders for manufacturers, which, in turn, impacted manufacturing. This can be expected to reverse in the second quarter. An unknown factor is the impact of demonetisation and GST on the unorganised sector. If that impact turns out to be worse than expected, growth recovery will take more time.
It is important to understand that the critical factor impacting growth is private investment. Between 2011-12 and 2016-17, private final consumption expenditure increased from 56.2 per cent to 58.8 per cent of GDP. So, consumption is intact and improving. But gross fixed capital formation, declined from 42 per cent to 38.4 per cent of GDP during this period, caused mainly by a dip in private investment demand.
Private investment expenditure declined due to a variety of factors like excess capacity in manufacturing, the highly leveraged balance sheets of companies and the high stressed assets of the banking system.
If private investment demand is to pick up and sustain the momentum, capacity utilisation has to improve.
Disconnect with global growth
The present downturn in the Indian economy has come at a time when global growth is recovering. If global growth continues to improve and the domestic growth continues to falter, that would be a serious concern. Normally, improving global growth provides the tailwind for higher domestic growth through recovery in exports. Indications are that the growth slump is a temporary blip caused by the impact of demonetisation and GST-related disruptions. Perhaps, this tepid growth may linger on for one more quarter, after which, recovery will be sharp.
Already, there are signals indicating recovery.
Leading indicators signalling recovery
Some leading indicators suggest growth is recovering. For instance, auto sales, which is regarded as a significant leading indicator, is picking up strongly. Auto sale was at an all-time high in August. Sale of passenger vehicles, commercial vehicles and two-wheelers showed impressive double-digit growth. Particularly, the growth in commercial vehicles sales at 27 per cent was a very positive indicator of recovery.
Another major positive indicator was the turnaround in exports, which recovered to 10.29 per cent in August from 3.94 per cent and 3.4 per cent in July and June, respectively. If this trend in auto sales and exports sustains in the coming months, that would augur well for recovery in GDP growth in the second half of FY 2018. Hopefully, GST-related disruptions too would be behind us soon.
Of late, capacity utilisation in manufacturing has improved from 71 per cent to 74 per cent, which is a positive signal. In brief, it appears that even though the target of 7.3 per cent growth for FY 2018 would be missed, economic recovery is on the cards. Earnings recovery might begin with Q3 or Q4 of FY2018 with a sharp recovery in FY2019.
It is important to revive growth and take to 8 percent and beyond. Only higher growth rate can generate jobs and reduce poverty. The question is: “how do we revive growth?”
Stimulus is like lunch, it’s not free
It is important that higher growth should be achieved with macro-economic stability. Stimulus – both monetary and fiscal – has a cost. India’s macros are stable now. This macro stability – lower fiscal deficit, lower current account deficit and moderate inflation – achieved with commendable monetary and fiscal effort should not be frittered away through knee jerk reaction to stimulate growth.
A major stimulus should wait till the Q2
GDP figures and other data like September auto sales and September exports. If these figures indicate recovery, the stimulus should be moderate. It is important to remember that the over-reaction to the Global Recession of 2008 led to the high inflation of 2010-12.The costs of a larger-than- needed stimulus may out-weigh its benefits.
There is only limited room for interest rate cut. Inflation in India, though moderate, is rising and the US Fed is on tightening mode. In this context, a 25 bp cut in policy rate is the maximum that can be done. Perhaps, RBI can do more on the exchange rate. The rising rupee has been hurting exports and causing import substitution thereby impacting domestic manufacturing. India cannot sustain a growth rate of above 7 per cent without double-digit export growth. Therefore, RBI should initiate steps to weaken the rupee. It appears that some initiatives are under way as evidenced by the recent rupee depreciation.