Insights into Editorial: Economy outlook still cloudy

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Insights into Editorial: Economy outlook still cloudy


 

Context:

Data released by the Central Statistics Office (CSO) showed the economy grew 5.7% in April-June, the first quarter of the current fiscal year, slower than the previous quarter’s 6.1% and much lower than the 7.9% growth registered in the first quarter of 2016-17.

The real growth of GDP, i.e. after removing the impact of inflation, was only 5.7%, much lower than expected. This steady declining trend in the growth rate is a matter of concern.

Some of the favourable factors of current economy

  • Inflation has been moderate, and touched a low of 1.5% recently.
  • Both trade and fiscal deficits are moderate and manageable. So they don’t eat up investible resources or precious foreign exchange.
  • The interest rate has been cut repeatedly over the past year and a half.
  • The inward rush of dollars is at a peak, both in financial markets (stocks and bonds) and as direct investment.
  • The stock market index is at an all-time high.
  • Oil prices have been stable and comfortably low.
  • Finally, the monsoon has been normal.

Despite these favourable macro factors, our economy has not managed to convert them into a higher growth rate. Even the Economic Survey Part 2 cautioned that there would be a potential loss of 1% growth.

Loss of 1% growth rate means a lot.  In nominal terms, one percentage less of growth translates into a loss of ₹1.5 lakh crore of national income. It also signifies millions of jobs not created.

Slowdown steepest in manufacturing,

The manufacturing growth at 1.2% is the lowest in the past five years. It’s the lowest since we switched to a new methodology (based on Gross Value Added).

Reasons:

  • Uncertainty related to the GST rollout on 1 July, which came about eight months after the government cancelled 86% of the currency, saw manufacturers cutting production and and consequent inventory deaccumulation. As a result, manufacturing growth slowed to 1.2% in the June quarter from 5.3% in the preceding quarter.
  • Bank credit shrank by 1.8%, i.e. negative growth. This is the lowest it has been for at least 13 years. A State Bank of India report said that credit growth for the year ending last March was the lowest in 63 years!

Growth rate in other sectors:

  • Service sector– trade, hotels, transport and communication etc. posted growth rate of over 7 per cent in the first quarter. Trade, hotels, and transportation, impacted by demonetisation in the March quarter (6.5%), rebounded to grow 11.1%, mostly due to discount sales ahead of GST implementation.
  • Mining activity contracted by 0.7%
  • Construction activity revived marginally from the negative print (-3.7%) in the March quarter to 2% in the June quarter
  • The agricultural sector grew 2.3 percent
  • The civil aviation sector saw passenger traffic soaring by 15.6%,

Significant Challenges before the government

The GDP is measured in at least two different ways. The first is by looking at the production side while the second is by looking at the aggregate of all spending, whether on consumption, or by foreigners buying our exports, or on investments into new factories and projects and government spending.

Big priority areas before government are-

  • Declining Private Investment:

Investment, which is between 30 and 35% of the total pie, needs to grow at least in double digits. Investment in future capacity creates GDP growth of the future. It needs to be led by the private sector. Currently, that component is barely growing at 1.5%.. As a result, capital formation is steadily declining for several years. Private sector investment has practically come to a standstill. Despite the push for ‘Make in India’, reforms for improving ‘Ease of Doing Business’, increased access to electricity, improvement in infrastructure and private investment are not picking up.

 

Initiatives such as Housing For All, Smart Cities and Digital India give room for huge opportunities for private entrepreneurs.

 

  • Twin Balance sheet problem:

The corporate sector and banks have been affected by the twin balance sheet squeeze wherein corporates are over-leveraged, and banks have mounting bad loans.

 

The new insolvency code and regulator and the Reserve Bank of India’s aggressive intervention may resolve this puzzle.

 

  • Strengthening rupee:

Another significant challenge to the domestic industry is the ever-strengthening rupee. Since January the rupee is 7% stronger compared to the American dollar. It is stronger than its Asian peer currencies too, including China, the Philippines, Indonesia and Thailand.

  • This directly hurts our export prospects. Due to this our exports are barely up 12% since January, whereas imports are up more than 30%.
  • More importantly, the strong rupee hurts the domestic industry since cheaper imports flood the country and eat into the market share of domestic players. The GST regime has given an extra advantage to importer traders since the countervailing duty that they now pay as GST can be offset against other taxes, a concession which was not available earlier. A jump in gold imports is also due to strengthening of rupee.

The need of the hour is to take measures for safeguarding domestic manufacturing industry from strengthening of rupee.

  • Effects at demonetisation

The first half of the last fiscal year, that is the period prior to demonetisation, recorded a real growth of 7.7%. The present April to June quarter’s growth at 5.7% certainly includes the negative impact of demonetisation on the informal and rural economy.

Investment and consumption spending which were postponed due to cash shortage might recover. But jobs that are lost are lost forever.

  • Low agricultural prices

The Economic Survey warns about the deflationary impact of low agricultural prices. The agriculture sector GDP shows nominal GDP growth to be lower than real GDP (values are adjusted for inflation), which is very unusual. It means that farmers’ incomes will be depressed, and doubling of farm incomes in five years becomes that much more of a distant dream.

Measures needed to spur economic growth:

  • One option would be to pump prime the economy through increased capital spending by the government.
  • Government Policies should focus on country’s development and people should give ideas for better governance.
  • Niti Aayog Vice Chairman said transformational ideas are the need of the hour to boost economy.
  • There is a need to modernise agricultural sector to increase productivity and income of farmers.

The Finance Minister has his task cut out: to find ways to restore momentum before the tailwinds of low inflation and affordable energy prices start reversing direction.

Conclusion

Perhaps in the coming quarters we may see a rebound. That will crucially depend on a big pick-up in manufacturing and private investment spending. The big structural reforms of GST, the new insolvency code, the new monetary framework and Aadhaar linkage are measures which will show results in the medium to long term.

What we need is an immediate stimulus to re-inject the momentum to get us to 8% growth.