The Central Statistics Office’s (CSO) provisional estimates for the Indian economy for 2015-16 have created a buzz. The estimates show the >Indian economy growing at 7.6 per cent in 2015-16, with a surge of 7.9 per cent in the last quarter. This has led some to conclude that 8 per cent growth is around the corner.
We need to put the celebrations on hold. In the short run, our growth prospects are constrained by global factors and fiscal consolidation at home. The medium-term story is jeopardised by continued weakness in the world economy, the problems in our banking sector and the fall in the investment rate.
Overall growth of 7.6 per cent for 2015-16 is in line with advance estimates. It is an improvement on growth of 7.2 per cent in 2014-15. However, there are three puzzles to the growth story.
The growth story, dissected First, manufacturing has grown at 8.1 per cent at current prices. This is not matched by the growth in the >Index of Industrial Production (IIP), which is only 2.4 per cent. Second, it is hard to explain how manufacturing growth has been so strong when exports as a whole have contracted. Third, as the Centre for Monitoring Indian Economy has pointed out, a big chunk of the growth in 2015-16 has come from an item called ‘discrepancies’ in the CSO’s statistics (in plain language, an item about which we know little). Of the growth of 7.6 per cent in 2015-16, 2.4 percentage points were accounted for by ‘discrepancies’. In 2014-15, the same item accounted for 0.1 percentage points out of growth of 7.2 per cent. Compare 2014-15 and 2015-16 after leaving out ‘discrepancies’ and the growth rate figures are: 7.1 per cent and 5.2 per cent. It is hard to be jubilant about something you don’t quite understand.
What about 2016-17? The upbeat view is that we can expect a boost to growth in the coming year from three sources: rural consumption (thanks to better monsoons), urban consumption (thanks to the impending Seventh Central Pay Commission award), and increased government capital expenditure projected in the Budget for 2016-17.
Alas, this upbeat view assumes that all other factors in the economy will remain constant. They will not. To grasp this, we need only to look at the analysis presented by the Mid-Year Economic Analysis (2015-16) and the Economic Survey (2015-16).
A key factor boosting India’s growth in 2015-16 was the decline in world oil prices. Lower oil prices translate into higher private consumption. The mid-year review estimated the boost to growth from higher private consumption at 1-1.5 percentage points, assuming that oil prices through the year would average $50 per barrel. The Economic Survey estimated that this benefit would continue to accrue to the economy in 2016-17, albeit to a lesser extent. It estimated oil prices for 2016-17 to be $35 per barrel. The gain to India’s economic growth on this account, it said, would be about half that in 2015-16.
Around 7 per cent and why This assumption threatens to be undone. Oil prices have already moved up to $50 per barrel. If they stay at this level, there is every prospect that the gains in 2015-16 on account of falling oil prices would be absent. The Pay Commission hike could contribute about 0.6 per cent of the GDP depending on how much of it is fully paid out in 2016-17. A better monsoon could add about 0.3 percentage points.
The net effect of private consumption on economic growth relative to last year would thus be minus 0.6 per cent (minus 1.5 percentage points due to the gain from lower oil prices being absent, plus 0.6 per cent due to the Pay Commission package, plus 0.3 percentage points due to the monsoon’s effect on rural demand). The recent rise in oil prices could thus overwhelm potential gains from better monsoons and the pay hike.
The mid-year review saw higher exports in 2016-17 as fully compensating for the loss in private consumption. It arrived at a projection of demand for India’s exports by estimating the weighted average growth of India’s trading partners. This proxy for export demand declined from 3 per cent in 2014 to 2.7 per cent in 2015.
The mid-year review expected that it would go back to 3 per cent in 2016, which would translate into exports contributing 1.3 percentage points to GDP. This projection too has been overtaken by adverse global trends. The Economic Survey expects that the proxy for export demand will improve only marginally to 2.8 per cent. Given global uncertainties, even this could prove to be optimistic. Thus, export growth can at best contribute 0.4-0.5 percentage points to GDP relative to 2015-16.
The third factor to be taken into account is government spending. Most analysts have got carried away by increases in capital expenditure projected in the last Budget. However, as the mid-year review correctly points out, in estimating the impact on aggregate demand, we should be looking at the fiscal deficit. The fiscal deficit factors in not just increases in capital expenditure but also declines in other government expenditure as well higher taxes. Fiscal consolidation planned for 2016-17 means that demand will shrink by 0.4 percentage points of the GDP.
Lastly, we cannot expect private investment to pick up given that corporate balance sheets are stressed and real interest rates very high. Adding up the pluses and minuses estimated above, we get a fall in GDP growth relative to the growth rate of 7.6 per cent in 2015-16 of 0.5 percentage points. This means that growth is likely to end up closer to 7 per cent in 2016-17, the lower end of the band of 7-7.75 per cent projected by the Economic Survey . And this is without factoring in the potential for upheaval arising from Brexit, a rise in U.S. interest rates and a further slowing down in China.
Problems in the medium term The medium-term prospects are not very encouraging either. Part of the problem is India’s increased integration with the world economy. The Economic Survey points out that as a result, the correlation between India’s economic growth and world economic growth has risen from 0.2 in 1991-92 to to 0.42 in 2015-16. It says that if the world economy continues to grow at around 3 per cent (which is what the World Bank and International Monetary Fund project until 2018), India’s growth rate is fated to remain in the range of 7-7.75 per cent.
The second problem is the state of the banking sector. Sorting out the bad loan problems, strengthening public sector banks and getting loan growth to industry to revive strongly will take another two to three years at the very least. A banking crisis, which is the failure of multiple banks, can derail an economy from its growth path for several years. We do not have a banking crisis but we do have a stressed situation. Getting out of it is not easy.
Third, the investment rate has fallen steeply. Gross fixed capital formation, which is a measure of productive assets in the economy, has fallen from 34.3 per cent of GDP in 2011-12 to 30.8 per cent in 2014-15. We need to increase the rate to 34-35 per cent.
Raising the growth rate to over 8 per cent in the next two or three years is a huge challenge. It’s a challenge that certainly cannot be overcome as long as we operate within the present straitjacket of fiscal consolidation and inflation targeting, policies that tend to reduce growth in the medium-term. Can the Narendra Modi government summon the courage to think very differently?
T.T. Ram Mohan is a professor at IIM, Ahmedabad.
