There was a collective sigh of relief when the second quarter GDP data were released officially by the Central Statistics Office (CSO). The government folks were relieved that a declining trend of four consecutive quarters of growth had finally been reversed.
The forecasters and economists were relieved that the announced data had mostly conformed to their expectations. Industry and business people were now hopeful that this was the first instance of a sustained upward trajectory of growth. GDP growth came at 6.3% for the quarter ending September, higher than 5.7% in the previous quarter, but still lower than 7.5% a year ago. The Finance Minister said that the effects of the demonetisation and initial rollout of the goods and services tax (GST) were behind us. (In saying so, he implicitly endorsed the view that indeed demonetisation and the GST rollout had been negative for the GDP, at least in the short run. But this is not the occasion for such minor nitpicking!)
Devil’s in the detail
All these responses of being assured that we had turned a corner are justified if we see some of the positive details from the GDP data. For instance, industrial growth accelerated from 1.6% during the June quarter to 5.8% in this September quarter. Its subcomponent, manufacturing, too grew faster at 7% compared to only 1.2% during the previous quarter. This data is a bit puzzling since it seems inconsistent with the data on the Index of Industrial Production (IIP), whose growth is only 2.2% during this quarter. The services component of trade, hotels, transport and communications also grew smartly at 10.5% for the half year, as compared to 8.3% a year ago. So much for the good news.
Industrial revival is an absolute must for sustained growth in employment and output. It should also be accompanied by an increase in private sector investment, which is still lacklustre. The portion of GDP growth coming from fixed capital formation (which stands for investment activity) declined from 27.5% in the first quarter to 26.4% now. This has to be closely watched, and needs high policy priority. All the improvements in the Ease of Doing Business (EODB) ranking are meaningless unless we see substantial pick-up in private sector investment. More about this later.
There was one more silver lining in the data. The CSO says that GST collections data are provisional, and could be an underestimate. To that extent an upward revision of the GDP data is possible in the future.
So if the GDP trend is satisfactory, why did the stock market react so negatively? It is of course hazardous to impute motives to the stock marker index movements, since there are multiple influences, both domestic and global. Several caveats are in order. The stock market has been scaling new peaks, even though GDP growth had been declining. The stock market is always a forward-looking entity, a harbinger of things to come. Whereas the GDP data released by the government describe what happened two or three months ago. The stock market is swayed by a relatively small minority of deep pocket investors (and increasingly algorithms and bots), so its reaction is not representative of what’s happening to the broad-based economy. Even so, despite these caveats, it’s useful to pay heed.
Spooked markets
The market was spooked by the data on fiscal deficit. At this stage of the fiscal year, the deficit is running at 96.1% of the annual target. Last year at this stage it was only at 79.3%. The revenue expenditure component (roughly salaries, pensions, interest payments, etc), which is not the productive spending on items like infrastructure, is growing at twice the rate as budgeted (10% against 5%). The higher deficit would have been acceptable had it been on account of higher capital spending, not higher revenue spending. The government can either cut further into capital spending (which tends to be discretionary, or can be postponed to the next budget year) or it can increase its market borrowing to tide over this year. Either way it is not good news for the markets. That’s because the former implies lower economic growth, and the latter implies higher interest rates. This could be the main reason for the markets crashing. Indeed, a fiscal slippage right after an upgrade by international rating agency Moody’s does not sound auspicious. Rating agencies tend to be fiscal fundamentalists, focussing disproportionately on fiscal deficits. They in turn influence bond investors, who might suddenly stop pouring dollars into India’s bond and stock markets. But markets are notoriously fickle. They might very well be more jubilant if the government exceeds its privatisation target this year.
Moving away from sentiments of Dalal Street, it is important to focus on the weaker components, which should become policy focus area. As said above, private sector investment is still anaemic. It is constrained by low capacity utilisation, deleveraging of balance sheets (as companies are reducing loan burdens), insolvency resolutions and large influx of imports, especially manufactured goods. Second, consumption spending has started losing steam. Its growth went down a notch from the last two quarters.
Nearly two-thirds of India’s GDP is consumption spending, and remains the key to sustaining the growth momentum. Its slowing means that purchasing power both in rural and urban areas is under pressure. Mounting inflation rates are not helping. The situation on job creation is still bleak. Large job creating sectors like construction, agriculture, textiles, leather and tourism need to exhibit more vim.
Exports are the key
Finally, among the biggest worries are India’s exports. The world at large is experiencing one of its strongest growth phases. Indeed, the International Monetary Fund has revised its growth projections upwards for most countries. In such a scenario, India’s sluggish exports stick out like a sore thumb. When the world economy does well, India’s exports should be flourishing. The exporting sector’s fortunes are closely linked with the manufacturing sector. Exports create jobs, especially in small and medium enterprises. Why can’t India’s small enterprises sell on global portals like Alibaba and Amazon? What are the hurdles? Is the GST framework (with delayed refunds) inhibiting the growth of exports? What are the policy and other bottlenecks? These are the issues that we need to grapple with to sustain an upward growth path.
We need to acknowledge that unlike last year, this year the government has less fiscal room to pump prime growth. Oil prices have gone up in the past few months, taking away the fiscal dividend. GST, Real Estate (Regulation and Development) Act, Insolvency Code are all great reforms for the medium to long term. But the next few quarters call for sustaining consumption, inviting private investment, energising agriculture, and giving a big fillip to exports. We have our work cut out.
Ajit Ranade is an economist
