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Issue No.: 577 | July 2015

Trouble Spots and A Way Forward

Sunil S. Bhandare
India’s economic recovery continues to be in a state of flux – and that the current performance is much below its potential growth rate!

Three major events have embroidered the economy in the early part of the second year of Modi Government’s tenure: first, the Central Statistical Organisation’s [CSO] release of the comforting growth numbers of the economy for the year gone by; second, Reserve Bank’s [RBI] as ever "cautious” growth and inflation outlook for the current year, and hence, "conservative” approach to reduction in key policy rates; and third, the most disturbing forecast by Indian Meteorological Department on likely severity of rainfall deficiency. The sum total of all these is the "certainty” about uncertainty in the emerging economic scenario; and hence, the imperatives of strategizing the way forward.

The RBI’s Perspective

Let us begin by reflecting quickly on the RBI’s second bi-monthly monetary policy [BMP] for the financial year 2015-16. It has reduced the key policy rates by 25 basis points for the third time in a row, taking the cumulative cutback to 75 basis points. Illustratively, the repo rate – rate at which banks borrow funds from the RBI against eligible collaterals, which in turn transmits signals for changes in the interest rates scenario in the economy – has been reduced since January 2015 from 8% to 7.25% now. In turn, this has enabled banks to ease the lending rates by about 30 basis points. Surely, this has not been commensurate with what the RBI Governor as well as the Finance Minister have been wanting the banks to do. Consequently, the continued weakness in the transmission mechanism of the RBI’s action is becoming increasingly apparent.

From our perspective, the BMP’s far more significant dimension is its comprehensive overview of current and emerging global and domestic economic scenario. Coming as it does after the CSO’s recent release of national accounts data for 2014-15, this overview offers some valuable leads about shape of things to come. Specifically, the RBI has marked down its earlier forecast of real economic growth rate [measured in gross value added = GVA] from 7.8% to 7.6% for 2015-16 as compared to the growth rate 7.2% in 2014-15. Contrast this with the government’s estimate of 8.1% to 8.5% real GDP growth rate in 2015-16! At the same time, the RBI has up-scaled the inflation projection from its earlier 5.8% to 6% by January 2016. What transpires, therefore, is that economy’s top-line performance would be delicately poised.

The RBI finds that the global economic recovery is slow and increasingly differentiated across regions in the wake of [a] the US economy shrinking in the first quarter of 2015; [b] the EURO area desperately combating economic slowdown through quantitative easing and with depreciating euro; [c] China’s continuing deceleration in spite of monetary easing; and [d] challenging macro-economic conditions in most Emerging Market Economies on account of domestic fragilities and bouts of financial market turbulence. Further, oil prices appear to be volatile; so also are the global financial markets. The latter is governed largely by changing expectations around the reversal of US Fed’s interest rate cycle and likely unwinding of European assets by investors due to the Greek crisis.

The domestic economic situation looks no less daunting thanks to [a] worsening of the agricultural situation in 2014-15 and the outlook for the current year being clouded by the latest prediction that the south-west monsoon will be 12% below the long period average and the threat of El Nino phenomenon; [b] uneven industrial recovery manifesting in sustained weakness of consumption spending, especially in rural areas, disappointing corporate sales and earnings performance, and falling capacity utilization in several industries; [c] revival of investment demand constrained due to stalled investment projects; [d] mixed signals of services sector; and [e] weakening of merchandise export growth. The BMP points out that net foreign trade is "unlikely to contribute as much to growth going forward as they did in the past financial year. Consequently growth will depend more on a strengthening of domestic final demand”.

In substance, the BMP per se and the subsequent interactions of the RBI Governor with the media tend to suggest that India’s economic recovery continues to be in a state of flux – and that the current performance is much below its potential growth rate!

A Growth Turnaround!

Against this backdrop, let us now proceed to reflect upon what the recently released CSO’s provisional estimates of national income convey about the state of the economy. The comforting fact is that the macro economy [real GDP] has cruised at an impressive rate of 7.3% in 2014-15 – that is in the first year of the Modi government as compared to the lower growth rate of 6.9% in 2013-14, which it inherited from the UPA government. Hence, it is quite justifiable for the government to proclaim that there is a significant turnaround in the economy. If there had been no major setback to the agricultural sector due to the wayward monsoon behaviour, then the growth rate could easily have surpassed 7.5% in 2014-15.

Interestingly enough, some official spokespersons waxed eloquent that in the last quarter [January-March] of 2014-15, India’s growth rate at 7.5% has overtaken that of China. Surely it has; but the government needs to be cautious that this is not a transient triumph. What matters most is to ape China not only in a singular quarterly growth rate, but also in her unprecedented quarter century of miraculous double-digit annual growth! Therefore, the immediate challenge before the government is how to take forward such moderate growth momentum and strategize a longer-term aspirational target of 8.5 to 9% sustainable growth rate? Hopefully, this aspect would now be the primacy of focus in the government’s economic policy formulations.

Areas of Concerns!

A careful evaluation of crucial trends from the CSO’s national accounts data unfolds many trouble spots in the current moderate growth recovery. First, the setback to the agricultural sector is an area of huge concern. Indeed, the agricultural GVA growth rate turned negative in the last two quarters -1.1% and - 1.4% in Q3 and Q4 of 201415, respectively. The worsening of agrarian crisis is certainly associated with this dismal performance. Needless to say, for stable, stronger and sustainable economic recovery, it is imperative for the agricultural sector to secure at least 3.5% to 4% annual growth rate. But this now seems most unlikely even in 2015-16.

Second, there is a noticeable turn-around in the manufacturing growth rate, which accelerated to 7.1% in 2014-15 as compared to 5.3% in the previous year. But neither industrial production nor infrastructure industries production numbers give credence to such manufacturing recovery. Surely, this sector has to expand consistently at a much faster rate to make a strong positive impact on current industrial and investment outlook.

Third, a predominant part of growth recovery has also been made possible by the services sector scoring a little over double digit growth. But most of it is attributable to stronger performance of the sub-sector "financial, real estate and professional services”, which gathered momentum at the rate of 11.5% in 2014-15 as compared to 7.9% in the previous year. The sub-sector "trade, hotels and transport and communications” also scored growth rate of 10.7% in 2014-15, albeit it was slightly lower than 11.1% in the previous year. However, to sustain such high services sector performance, the commodity sectors like agriculture, mining, quarrying and manufacturing as well as construction have to expand at a much faster pace.

Fourth, an important revelation from the national accounts data is that foreign trade [imports + exports of goods and services] as percentage of GDP has been shrinking progressively – the share was 55.6% in 201213; 51.3% in 2013-14 and has dropped to 47.1% in 2014-15. The fall in international crude oil and commodity prices offers one explanation, and is most welcome. But more worrisome factors are: [a] contracting exports, perhaps indicative of falling export competitiveness; [b] subdued global export markets; and [c] decelerating capital goods and project imports, reflecting stagnant investment activity. Does this mark a retreat of globalisation for the Indian economy? This issue must exercise the attention of the policy makers and the RBI – the latter specifically on issues concerning appropriate exchange rate of the rupee.

Last, from the macro growth perspective what matters most is [i] consumption demand; and [ii] investment demand. Concerns of fiscal consolidation have caused some slowing down of government’s consumption expenditure growth, which is most welcome. But stagnation of private consumption expenditure growth is a matter of great concern. This seriously impairs the fortunes of manufacturing sector. Even more worrisome is a continued drift in the investment ratio, manifesting in gross fixed capital formation to GDP ratio, which declined from 31.9% in 2012-13 to 30.7% in 2013-14 and further to 30% in 201415. In a perspective of longer term scenario, the collapse of domestic savings and investment activity becomes far more conspicuous. Effectively, the economy has seen a contraction of as much as 6 to 8 percentage points in both savings and investment ratios. For the economy to expand at a faster pace, the savings ratio has to surge from its current level of about 30% to 35%; and investment ratio from 30% to 37 - 38% over the next three to four years.

The Way Forward

In substance, the growth recovery of 2014-15 hangs on a balance. In the context of bleak forecast of southwest monsoon, the struggle for sustaining [leave alone accelerating] the economy’s growth momentum is going to be hugely formidable. What is the way forward? First, there is a growing perception that "seeds are sown, shoots are awaited” – "foundations have been laid, structures can be built up”. If this is so, then the implementation of 2015-16 budget proposals and various other policies [including the pursuit of game changing reforms like GST] must now gather greater momentum. Second, after a year-long aggressive diplomatic initiatives, the Prime Minister will now have to consolidate the gains based on promises of economic cooperation, including various project related investment agreements – and all that would surely add up to tidy potential investment activity.

Third, the RBI has so far done its bit in cutting the interest rates, but further monetary easing would inevitably depend more on effective inflation control by the government. In turn, this would depend more on how supply and distribution management of food grains and other essential commodities is going to be managed. Besides, it has also to organize extensively the support system for farming operations by making special provisions of extra seeds and other essential inputs, including water in the wake of likely severity of monsoon failure. For a longer-term sustainability of the agricultural sector, it is imperative to expedite expansion of irrigation [including micro irrigation and watershed development], consolidation of land holdings, and rural infrastructure development as well as improvement in quality and effectiveness of schemes like MNREGA (The Mahatma Gandhi National Rural Employment Guarantee Act).

Fourth, key infrastructure ministries dealing with roads, railways, power, etc. have in recent months been sounding eloquent about their ambitious programs of expansion and new investments. Now is the time for execution of such projects. Fifth, so much has been said about the "Make in India” mission. The government would now be expected to strategize and implement many of its policy pronouncements on this count. At the same time, it must also respond to the issues raised by business and industry and also by its own Chief Economic Advisor. The latter has offered some well-meaning suggestions: [a] scrap the proposal to impose 1% tax on inter-state sales as an integral part of GST; [b] calibrate the exchange rate – don’t allow the rupee to become more uncompetitive; [c] reduce the key policy rates in conformity with falling inflation rate, improved fiscal management and the global environment; and [d] liberalize FDI norms in multi-brand retail.

Finally, in the prevailing style of governance, the most powerful driver of a more balanced and sustainable growth, infrastructure investment, and series of social security programs would be the concerted and coordinated efforts under the PMO’s direction. Most keen observers are surely willing to wait for some more time for the government to deliver development with good governance. But patience certainly has its time horizon – it would start tapering rapidly beyond the second year of government’s tenure.

SUNIL S. BHANDARE is a Consulting Economist based in Mumbai.



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Tribute to S. V. Raju

Truly, The Complete Man

Vivek Raju

S. V. Raju: A Political Rishi

Nitin G. Raut

Memories of S. V. Raju

Sharad Joshi

Raju Lived for a Cause

Y. Sivaji

S. V. Raju: A Personal Tribute

Minoo Adenwalla

My First and Only Meeting with S. V. Raju

Ronald Meinardus

My First and Last Meeting with S. V. Raju

V. Krishna Moorthy

Tributes from Friends


The Economy

Trouble Spots and A Way Forward

Sunil S. Bhandare

Point Counter Point : Every issue has at least two sides

Modi's Year in Power

Ashok Karnik

AAP's Ambition

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Cricket with Pakistan

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Facts and Rumours

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Life and Death

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Questions Needing Answers

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Foreign Relations in the 21st Century

“Manufactured Sovereignty” in South China Sea: Sino-American Confrontation Heats Up

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Book Review


S. V.Raju


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Educating Adults

Examination Reforms at the Bachelor’s Level

R. W. Desai

A Doctor In The Air: Ancient Aviator Anecdote

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The History of the Swatantra Party

The Swatantra Party in Gujarat: A Shooting Star (Part III)

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