What accounts for the recent improvement in the economic outlook?

A slew of economic numbers released over the past 10 days or so do give rise to optimism. However, it is far too early to interpret these as the beginning of a long awaited turnaround. What accounts for the recent improvement in the economic outlook?

Consider the following:

Industrial output figures for July (as measured by the Index of Industrial Production (IIP)) was surprisingly strong increasing by 2.6 per cent on a year-on-year basis after two consecutive months of decline.

On the trade front, in August, India’s exports posted a double-digit growth, the second time in two months.

Imports declined on the back of a sharp fall in gold imports.

As a consequence, the trade deficit declined to $10.9 billion, and that might have relieved the pressure on the rupee to some extent.

Apart from the trade data and the unexpectedly strong IIP numbers, retail inflation (CPI index) eased slightly although still remaining high.

The rupee recovered sharply on Monday, and has since moved in a narrow trading range of between 63 and 64 to the dollar. At those levels, it is significantly lower than it was during the time it seemed inexorably headed towards 70 and beyond.

Also, at the beginning of last week, the Sensex surged by more than 700 points, reflecting the recent positive data as well as the easing of tension over Syria.

Key question

The key question is whether the virtuous circle of improved economic news leading to better sentiment will remain for a reasonable length of time.

It is pertinent to recapitulate that the official forecast of gross domestic product (GDP) growth for the current year (2013-14) has remained at between 6.1 per cent and 6.7 per cent. However, improbable that seemed, it was left to the Prime Minister’s Economic Advisory Council (PMEAC), while releasing the Economic Outlook on Friday (September 13), to forecast a substantially lower 5.3 per cent growth. Though lower than the estimates of the RBI (revised 5.7 per cent), it is still much higher than the several estimates of other forecasters which range from as low as 4 per cent to a high of below 5 per cent, which was last year’s official (Central Statistics Office’s) growth estimate.

Farm sector

The PMEAC expects a vastly improved performance by the farm sector to grow at 4.8 per cent as against 1.7 per cent in 2012-13. Industry, still constrained by falling mining output as well as weak manufacturing, will clock 2.7 per cent (2.1 per cent) and services 6.6 per cent (7.1 per cent last year).

Obviously, there would be sceptics who would question the validity of the PMEAC’s estimates. Are they too optimistic? Part of the answers can be found by looking at recent economic data, especially the July IIP and the August trade figures.

Industrial output figures look impressive only in a relative sense. Mining output continued to contract. Manufacturing and electricity, however, turned in a much better performance in July growing by 3 per cent and 5.2 per cent, respectively. Manufacturing has a large weight in the index. A detailed analysis shows that it has grown largely due to a nearly 84 per cent increase in just one sub-segment, electrical machinery and apparatus industry. Excluding this segment, manufacturing fell by 0.9 per cent in July over last year.

In fact, from April to July, manufacturing output has declined by 0.2 per cent. That would cast doubts on the PMEAC’s projection for industry.

The rating agency Crisil points out that export-driven industries such as textiles and leather have turned in an impressive performance, most probably benefiting from the rupee depreciation and strengthening global demand. In turn, the trade deficit should shrink. If IT and ITeS sectors perform well, the current account deficit (CAD) will also come down. The PMEAC, however, still considers the containment of CAD to be the principal challenge of policy.

Falling imports of gold, capital goods and consumption goods need to be interpreted carefully. On the face of it, they are to be welcomed but then, given the ever-persistent demand for gold ahead of the festival season, it is possible that a part of the trade has gone underground. Fall in imports of capital goods correlates with declining economic activity at home ,and is, therefore, not altogether positive.