Indian economy: present imperfect, future cautious

The GDP growth in the first quarter (April to June) of this fiscal year 2016-17 came in at 7.1% annually, much lower than 7.9% clocked in the previous quarter (January to March) and also lower than 7.5% during the same period last year.

There was not much gloom-and-doom in the market as growth still continued to chug comfortably at above 7 and India maintained its claim as the fastest growing major economy in the world ahead of China.

While most economists focused on the decelerating real growth number, Arvind Subramanian, Economic Advisor to the Ministry of Finance, highlighted the accelerating nominal growth number. According to him, the economy is definitely on the upswing as nominal GVA (Gross Value Added) was at seven-quarter high and almost at double-digits (9.9%). This calls for a closer look at the latest growth number.

The surprise element in the growth numbers was the real GDP growth at 7.1 coming in below GVA growth of 7.3% – a fall of 0.2 percentage points (ppt) after growing 0.5 ppt above in the last quarter. We know that GDP is equal to GVA plus Net Indirect Taxes (where NIT = Indirect Taxes minus Subsidies). So, the numbers are clearly indicating that the problem lies with the NIT.

In other words, indirect taxes must have slowed and subsidies increased. This is corroborated by the monthly budget numbers of Controller General of Accounts which show that the excise, customs and service tax collection in the first quarter FY 2016-17 (April-June ’16) slowed to 60.5, 17.8 and 28.5% annually from 104, 22 and 14.2% during the same quarter last year. Additionally, the Central Statistical Office (CSO) press release stated that the growth in subsidy payout increased to 53% and as against a contraction of 26% same time last year.

Next, the nominal growth incorporates  impact of inflation compared to real growth numbers. The nominal GVA in first quarter grew at 9.9%, almost doubling from 5% witnessed in the second quarter (July-Sept) last year. In the same period, CPI inflation had increased by 1.7 ppts and WPI by large 5.8 ppts. So, it is debatable whether the nominal growth increased due to improvement in underlying real activities or rise in inflation.

Looking at the GDP from the supply side, we see that agriculture growth, impacted by two consecutive droughts, remained muted. Industry growth came in lower than expected on negative mining and weaker construction growth. Most probably, the clampdown on black money resulted in weakness in the real estate and construction sectors. On the other hand, the services sector grew at sn impressive 9.6%. But the fizz evaporates as we look at the details. The services sector growth was primarily due to higher government spending.

On the expenditure side, things were not any better. Growth was largely led by consumption, particularly government consumption. Consumption contributed 5.7 ppt to the GDP growth of 7.1% – about 80% of growth. Investment declined further, contracting for two consecutive quarters. However, net exports (exports minus imports) contributed positively to overall growth.

This was because exports growth moved to positive territory in June after registering negative growth for 18 consecutive months and imports growth contraction was much deeper than exports in the first quarter. This is, by no means a welcome news, as imports contraction for 19 months continuously underscores weakening domestic demand or economic activities.

Consumption to strengthen

Going forward, the recovery will remain slow. Agriculture growth will improve as crop sowing and reservoir levels remain comfortable despite weakening monsoon with rainfall at 5% below normal. This will help rural economy. In addition, higher MNREGA spending along with expected hike in MSP for some crops ahead of state elections will boost rural demand.

Urban demand will get a leg-up by the Seventh Pay Commission. So, consumption is expected to strengthen in the coming quarters. The recent industrial production number (a contraction of 2.4% in July) with a broad-base weakness, does not point to strong manufacturing growth in the coming quarter.

Anaemic external demand will keep exports growth muted. High frequency data like capital goods imports, capital goods production under IIP, capacity utilisation data and CMIE data on project implementation have remained lacklustre.

Corporate balance sheet problems in certain sectors, NPAs in PSU banks along with weak domestic and external demand do not raise expectation of capex recovery. The growth recovery in this cycle will be led by consumption, public spending, higher market liquidity and foreign investment flows.

Depressed oil and commodity prices will help keep inflation on RBI’s projected glide path. Consumer inflation has already decelerated to 5.05% (annual change) in August from 6.07% in July as rains have doused the food prices.

This will eventually open up space for the new RBI governor to cut repo rate further. Appointment of Urjit Patel as governor signalled policy continuity in the central bank. Patel had been chairman of the committee to draft the report on ‘Flexible Inflation Targeting’ and based on that report, the inflation target is already hardwired into the law.

The government has also shown considerable restraint in last two and half years and avoided fiscal populism like higher MSP, farm debt waiver etc, despite several state elections. Staying away from fiscal and monetary growth steroids, commitment to low inflation and macro-stability and focusing on tough structural reforms are positive in the medium-term. However, in the short term, higher subsidy payout, pay commission expenditure and lower disinvestment receipts can put pressure on fiscal consolidation target for this year.

Overall, the glass remains half-full but it is hardly the time to be complacent. The present remains imperfect and the future cautiously optimistic.

(The writer is a Visiting Fellow at PIF, New Delhi, research scholar at IIFT and an adviser at Policy Monk)