Key drivers point to further economic slump in Q3

Government spending is running the show on India’s economic growth front. If one removes the government final consumption expenditure (GFCE) from the 4.5% GDP print in the July-September quarter, the growth rate could fall to roughly around 3.5% or thereabouts.

In fact, among the four components of the gross domestic product (GDP) – personal consumption, private investment, government spending and net exports – only one, government spending, has been lifting the economy up. The state of the other three is far from satisfactory for a long time and does not point to immediate recovery.

The private sector is neither showing any signs of upping consumption nor investment. Growth in private consumption, which comprises about 60% of GDP, has almost halved from 9.78% in the July-September quarter of 2018-19 to 5% this year.

This is the mainstay of India’s economy and needs to be fixed in order to achieve a high headline GDP number.

The past data sets suggest that all previous quarters of high GDP growth has been supported by a robust private consumption. For example, in January-March quarter of 2017-18, when the economy logged an 8.1% growth rate, the private final consumption expenditure was 8.73%.

Subsequently, in the April-June period in 2019-20, when the growth rate fell to 5%, private consumption dropped to a slender 3.13%. It has revived since to 5% in the current quarter under review on the back of several post-budget fiscal and monetary measures but it is difficult to predict on whether it can sustain for a long time, in the wake of sectoral problems. Real estate, auto, FMCG and capital goods sectors need to come out of the woods.

It is really difficult to say what should be the policy mix to get this important sector out of its current muted state. But, the heavy lifting done by the monetary policy so far this year has helped a little. Perhaps, the government needs to actively deploy the fiscal policy levers in a more aggressive way. It has given Rs 25,000 crore support to the housing sector last month but the consensus is that it was too little too late.

Now, there are constraints to an expansionary fiscal policy, especially as we near the Budget presentation. But before discussing that, let us look at the state of investment as presented by the latest data set.

Series of problems

Investment, especially private investment, a key driver that supports demand, creates capacity and increases labour productivity, has collapsed. It has declined to -1%.

This is quite opposite to the blueprint of this year’s economic survey that proposed private investment-led growth in place of consumption for India. This kind of a decline in investment may pose a serious problem to Chief Economic Adviser K Subramanian, who is in the midst of preparing a new economic survey ahead of the upcoming Budget.

His projection, back then, was that the decline in investment rate had bottomed out and was expected to pick up in 2019-20. Subramanian was widely criticised and questioned for his support to investment-led growth in the backdrop of a huge fall in household savings.

Related to India’s consumption and investment story is growth in bank credit. The sectoral deployment of bank credit for the month of October suggests that loan to industry and services has declined by Rs 1.62 lakh crore.

The fourth pillar of exports has either been contracting or showing a meagre expansion for quite some time. It began with the global headwinds, aggravated by increasing cost of raw material and high-interest rates. The slowdown in exports has had a major impact on the performance of the manufacturing sector.

The competitive trade restrictions followed by countries including India has had an adverse impact on exports. Export bodies have urged the government and the RBI to take further steps, including making steel available at competitive prices, to give a competitive strength to exports. This sums up the story of real GDP growth in the second quarter.

Nominal GDP

A look at the nominal GDP, which accounts for the price change and inflation in the economy, shows it has crashed to 6.1% or nearly half of this year’s budget estimates. The nominal GDP growth is at its lowest level in the past 16 years. This will not only spell bad news for the country’s fiscal deficit but also lead to lower tax collection and higher debt-to-GDP ratio. At 67%, India’s debt-to-GDP ratio (centre and states combined), is already the highest among the emerging market economies. Only Brazil has a higher debt-to-GDP ratio than India. It is close to 80%.

Finance Minister Nirmala Sitharaman is currently reviewing the revenue position of the centre and states in the run-up to the union budget. She has stopped short of hazarding any guess on fiscal deficit numbers.

But, the target of fiscal deficit at 3.3% in FY20 is simply not possible with 6% growth in nominal GDP. Amid growth concerns, she can also not go in for any major expenditure cut. The Centre will have to keep up its spendings in order to save the economy from any precipitous fall in the third quarter (October-December) because all key indicators – core sector, factory output, home and auto sales, oil consumption and the government’s freight earnings-- suggest that the growth could further slowdown in the upcoming quarter.

The growth worries and shrinking fiscal space with the government suggest the RBI will remain in a fire fighting mode.

It can afford to ignore the latest retail inflation number in October, which printed 4.62% or a tad higher than its target range because inflation shot up mainly due to vegetable prices, which has seasonal implications. The RBI, in all probability, will choose to cut the key policy rates on December 5, because if the economy accelerates, it can solve too many problems, even price rise. It remains to be seen how sharply the RBI cuts this fiscal year’s growth forecast. That will give direction to further policy steps.