Watering the green shoots

More than ever, non-economic factors will play a key role in determining whether the investment sentiment is sustained or not. Policymakers need to be conscious of this, and keep away from divisive and disruptive issues

We are now in the middle of the fiscal 2016-17. The main monsoon is also over. This is an appropriate time to take a look at the economy and assess where we are headed. Two important questions that spring up are: are there green shoots which show a decisive revival of the economy, and have we laid the foundation for a faster rate of growth of the economy in the medium term?

In analysing the trends in the economy, we continue to be plagued by conflicting sets of data. National income data are available only for the first quarter (April-June). These data show that GDP grew by 7.1 per cent and that value added in manufacturing grew by 9.1 per cent. However, according to the Index of Industrial Production (IIP) during this quarter, manufacturing fell by 0.6 per cent. The Central Statistics Office (CSO) now uses IIP data for measuring only a small segment of manufacturing. It uses the corporate data for estimating 75 per cent of the manufacturing sector. While one cannot fault the CSO for the new methodology, it has to carefully cross check the data it relies upon. Analysts need some amount of reassurance from the CSO. All the same, an attempt can be made to find out whether the current year will be better than the last year by looking at the performance of different segments.

Agricultural production

Looking at the problem from the supply side, the one segment that will do better is agriculture. This is based purely on the better performance of the monsoon. In the short run, rainfall is an important factor influencing agricultural production. The rainfall during the monsoon over the country as a whole was 97 per cent of the long period average (LPA). This is somewhat lower than what was originally predicted. But this is distinctly better than last year when the rainfall was only 86 per cent of LPA. The Southwest Monsoon rainfall in the current year is 100 mm higher than last year, which is approximately 13 per cent higher than last year. Based on a study of the impact of rainfall on agricultural production, this should lead to an increase in value added in agricultural and allied activities by 2.7 per cent.

Demand side perspective

From the demand side, there are four elements that we need to examine: private consumption expenditure, government expenditure particularly on investment, private investment particularly corporate investment, and external demand. As far as private consumption expenditure is concerned, a major factor contributing to a push is the implementation of the recommendations of the Seventh Pay Commission. Government’s salary and pension expenditures are expected to rise by 20 per cent. As those recommendations were made effective only from August 2016, the impact on the production of consumption goods will be seen only in the second half. There is evidence of some sectors like two-wheelers growing fast. The impact of the good monsoon on rural demand may also show up in the second half.

Total Central government expenditures in the first half were 52.0 per cent of the budgeted expenditures for the year. This is only a shade higher than previous year. Capital expenditures have shown a rise of 4.6 per cent over the previous year. Increase in capital expenditures is welcome as they lead to greater investment. In September 2016, capital expenditures grew by 20 per cent on year-on-year basis. However, this was mainly due to the increase in loans disbursed. It is to be noted that the bulk of the public investment comes from public sector enterprises. As of now, there is no information how much additional investment has been made by PSUs. Roads and railways seem to be doing well.

The third important segment is corporate investment. In the last several years corporate investment has been roughly one-third of the total Gross Fixed Capital Formation. Therefore it is critical to watch its behaviour. The Reserve Bank of India has been making a forecast of corporate investment based on a methodology outlined by me. In the September 2016 issue of RBI Bulletin, it has provided the outlook that emerges for 2016-17. Bulk of the investment expenditures in any year are the result of the projects initiated in the previous two to three years. With the slowdown in new projects undertaken in recent years, it is unlikely that investment expenditures by the corporate sector in 2016-17 can be higher than in 2015-16. The study by RBI staff indicates that substantial investment in the projects initiated in 2016-17 will be required to equal previous year’s total investment expenditures. The total cost of projects initiated with institutional assistance in 2015-16 was Rs.954 billion, and Rs.878 billion in 2014-15. All this is a far cry from the figure of Rs.2,754 billion in 2006-07.

External environment

The external demand is largely a reflection of the world economy which shows a sluggish recovery. All forecasts indicate a slowing down in the world growth rate in 2016. The expectation is a slight improvement in 2017. World trade is also slowing. Exports of India started declining in 2015-16. For the year as a whole, the decline was 15.5 per cent. Much of this was due to the fall in the value of oil exports. However, some improvement in the current year is seen. The decline in exports during April-September was 1.26 per cent. This is on a base which had already declined. In the month of September 2016, exports grew by 4.03 per cent. In an environment of declining world trade, it is not surprising that India’s exports fell. However, data for 2015 showed that the India’s share in world exports has had a small decline, which indicates our exports are slowing down more than world exports. But as indicated earlier, India’s exports are doing a little better this year. We need to maintain this momentum. India’s current account, however, has been comfortable because of the sharper decline in imports. The external environment may not provide much stimulus by way of demand.

Green shoots

Thus, the positive signs in the economy are an improved agricultural performance and a pick-up in rural demand, some increase in private consumption expenditure primarily due to the implementation of the Seventh Pay Commission recommendations and an enhanced capital expenditure by government. The negative indicators are a continued stagnation in corporate investment and a poor external environment. The growth rate of GVA (gross value added) at basic prices in 2015-16 was 7.2 per cent. This year it may be slightly better at 7.6 per cent mainly because of improved agricultural performance. This estimate of the growth rate will undergo a downward revision if the disruptions caused by demonetisation persist for a long time.

The Indian economy has acquired a certain amount of stability. Prices are under control. Both CPI (consumer price index) and WPI (wholesale price index) inflation are below 5 per cent. Improved agricultural performance may further moderate food prices. The fiscal picture has been under control, even though as of now the fiscal deficit is running high. The current account deficit remains subdued. For the current year, it may be lower than last year’s level of 1.1 per cent of GDP. All these are favourable factors for sustained economic growth. The banking system is however under stress.

On the reforms front, there has been some improvement. Initially, there was the amendment to the Insurance Act to facilitate larger foreign investment. The Bankruptcy Act has been enacted. The real estate sector now has a regulator. Finally, the goods and services tax is becoming a reality. All of these are enabling legislations. The impact of these legislations on the economy will take some time to come. But they are moves in the right direction.

To maintain a high growth rate in the medium term, a kick start in investment is imperative. This is yet to happen, even though the investment sentiment is slightly better today. But more than ever, non-economic factors will play a key role determining if this sentiment will be sustained or not. Policy-makers need to be conscious of this and keep the focus on growth, and away from divisive and disruptive issues.

C. Rangarajan is former Chairman of the Economic Advisory Council to the Prime Minister and former Governor, Reserve Bank of India.

The positive signs are an improved agricultural performance and a pick-up in rural demand, some increase in private consumption and enhanced capital expenditure

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