Even as headline GDP growth slows, the pickup in investments is making it more balanced
Neelkanth Mishra | Last Updated at December 4, 2018 23:30 IST
(This was published in the Business Standard: link)
The economy seems to have ‘slowed’ earlier than most forecasters expected, and even before the funding freeze for non-banking financial companies (NBFCs) started hurting economic momentum. Most believed that this year would be a mirror image of the previous financial year, which had a very weak first half (disruptions caused by demonetisation and GST had pushed economic growth down to 6 per cent), and a stronger second half (7.4 per cent growth as the economy started to normalise). So, economists had pencilled in a strong first half in this financial year, helped by the ‘base effect’, and a slightly weaker second half.
The assumption behind such forecasts is that there is an underlying momentum in the economy, and reported statistics can be distorted if the same period in the previous year had seen a one-off problem. Calculating the average growth over two years allows us to look through the disruption and measure the underlying momentum. In the previous five quarters, this had been remarkably steady between 6.8 per cent and 7 per cent: Even the 8.2 per cent growth reported in the June quarter was on the weak base of 5.6 per cent in the previous year. Not only was the 7.1 per cent growth reported for the September quarter below what most expected, but it also takes two-year growth down to 6.7 per cent. As the strong base of the second half last year catches up, the headline growth numbers could drop to worrying levels.
To be sure, the analytical utility of quarterly GDP data is not great. Given the high informality of the economy, even annual GDP involves quite a bit of estimation by the Central Statistics Office (CSO); for quarterly GDP, the availability of appropriate datasets is much worse.
But the fact that growth preceding the ongoing problems in credit provision was already weak is a reason for concern. GDP growth of 7.5 per cent to 8 per cent that forecasters assumed for next year now looks increasingly unlikely, as it would require more than a one percentage point pickup in growth. NBFCs, which accounted for as much as 30 per cent of the incremental credit in the economy in the last three years, are slowing sharply, with many currently shrinking their balance sheets and selling some of their best assets to banks to raise liquidity. Their borrowers are feeling the pain: Anecdotally, many distributors, dealers and other small/medium enterprises are having problems raising working capital. While this lasts, it will hurt growth.
It may also impact the outlook for interest rates, as growth seems to be below the rates that the Monetary Policy Committee (MPC) has assumed. The MPC’s mandate is to keep inflation range-bound, and weaker growth brings down inflationary pressure. With food inflation staying weak and lower petrol and diesel prices possibly shaving a third of a percentage point off inflation, a debate on rate cuts can start again.
But there was a fascinating takeaway in the constituents of GDP as well: The slowdown seems to be mostly in consumption, even as investments grew in double digits for the third quarter in a row. The weakness in private consumption was despite corporate commentary staying positive through the quarter and, although quarterly results were below expectations in aggregate, the growth compared to the same quarter last year was quite strong. So, the recent GDP data suggests that overall consumption may not be as robust as seen in larger firms’ sales growth, even as we wonder how the CSO got the data to report this slowdown if it is driven by the informal sector (there is no good data on this almost by definition). In addition to the well-flagged reasons like formalisation induced by the start of GST, it could be because weak food prices slow down income transfer from the (more formal) rich to the (primarily informal) poor.
Slowing consumption, even if a bit ahead of expectations, was in a way necessary, given the large balance of payments deficit that the economy was running between June and August. Now that the decline in the price of crude oil has brought that deficit down to nearly zero, if oil prices remain at these levels, there is no need for a further slowdown. In fact, compared to the first half, the economy would save nearly Rs 1.1 trillion, a third each of these going to households, transporters and industry, providing some support to consumption. However, indicators since the end of the September quarter seem to suggest that the momentum in consumption has weakened, implying that future GDP readings could be even weaker. It started with the large-ticket discretionary items like cars, but is now spreading to other categories too. The fading effect of the seventh pay commission, which in aggregate increased the salary and pension payouts by central and state governments by Rs 4.5 trillion (nearly 3 per cent of GDP) could be a factor here: Maharashtra is among the last states to implement this, starting January 1, 2019.
The steady pickup in the investment to GDP ratio is the only encouraging data point, but a meaningful one. A disproportionate share of this investment is being undertaken by state and central governments: Large extra-budgetary spending by state governments has perhaps gone unnoticed, and there seems a certain sense of disbelief among economists and investors that this could be happening. This is more so because the euphoric sentiments that accompanied the previous investment cycle upturns are missing. State governments are spending in areas which have seen chronic supply constraints like urban transportation. Further, 7 per cent GDP growth compounded over five years adds 40 per cent to demand, and in many sectors capacity is starting to become tight. The obvious ones are airports, telecommunications, and even steel, where India has turned into a net importer again. With peak power demand growing rapidly (early last month I saw an ice-cream shop in a village in north-east Bihar — power availability would have improved dramatically for the retailer to agree to keep a freezer!), it is a matter of time before power generation investments become necessary again.
These are early days in terms of the turn in investments, but it seems that the advent of the insolvency and bankruptcy code has made business groups less venturesome with debt-funded speculative expansions — one reason the euphoria is missing. Aggressive investments that threaten the firm’s solvency so far only appear to be to retain market share. Even as one hopes this does not falter, the pickup in investments brings a much-needed balance to India’s GDP growth, even as overall momentum slows.