It’s not all gloom

Policy will decide if growth slowdown is a cyclical or structural problem

Written by Jahangir Aziz | Published:February 16, 2012 3:58 am

Policy will decide if growth slowdown is a cyclical or structural problem

And so the inevitable has occurred. India’s FY12 growth is now officially pegged below 7 per cent. Not that this is surprising. For sometime now,many had expected growth to slow down markedly. High frequency indicators like industrial production,exports,purchasing managers’ index (PMI) were all pointing to a pretty miserable second half of 2011.

But there is something about an official estimate. It lets one partake guiltlessly in the national soul-searching about why all this has come to pass,where we are heading,and whether India can go back to the 9 per cent growth trajectory. To be sure,it is not really gloom and doom. Recent goods and services PMI prints,industrial production (sans capital goods),vehicle sales and exports all suggest that this quarter could see a pick up in growth. The CSO’s extrapolation techniques have typically failed to pick up turning points in the past so that they could be underestimating growth for FY12. That said,the turnaround is hesitant at best and India’s main growth driver,namely corporate investment,remains disconcertingly weak.

If growth were to print close to 7 per cent in FY12,it would be the second lowest growth rate in the last decade,higher only that in FY09 — the year of the global crisis. Furthermore,it is a significant comedown from the 8.4 per cent average over the previous two years and the 9 per cent growth implicitly assumed in the FY12 budget.

The reasons for the FY12 slowdown do not need much reiterating. Investment growth,which has remained sluggish over the last two years,slumped even further this year in the wake of governance issues,binding supply constraints (land and coal,in particular) and monetary tightening. Private consumption growth,which has driven growth since the financial crisis,also slowed as the elevated inflation and higher lending rates took their toll. While a moderation in consumer durables was partly by design,given the RBI’s conscious effort to slow interest-sensitive components of demand,non-durables have also decelerated sharply as urban purchasing power got squeezed. On the positive side,company sales and wage data suggest that rural consumption growth is still strong.

Adding to the misery has been an appreciable decline in export growth,pegged at 14 per cent this year compared to 23 per cent last year but this was always to be expected as the global economy moderated. Au contraire,the fact that exports are still growing twice as fast as GDP suggests that the export slowdown is not as bad as commonly perceived. Equally culpable has been the rise in imports and from a surprising new source — coal — reflecting domestic supply constraints (mining output is estimated to decline by over 2 per cent this year) brought on by the delay in allocating new coal concessions.

Among all these developments,the one that is scary is the continued slump in investment. Overall statistics on investment paints a benign picture. Fixed investment (excluding inventories and valuables) has fallen a touch from its peak of around 33 per cent of GDP in FY08 to around 32 per cent of GDP in FY12 (gross investment has remained broadly stable around 38 per cent of GDP). But the devil is in the details. Investment in equipment — the one that drove India’s productivity over 2003-8 and propelled growth to the 9 per cent level — declined from 18 per cent of GDP in FY08 to 15.5 per cent of GDP in the wake of the crisis in FY09 and since then has remained virtually unchanged. Investment in structures (homes and bridges) is no doubt critical,but the sharp decline in equipment investment has reduced productivity markedly. More generally,corporate investment,which rose from 7 per cent of GDP to 18 per cent over 2003-08,has fallen to less than 14 per cent of GDP. And with no sign of an early turnaround,prospects of returning to the 9 per cent growth trajectory looks difficult.

What caused this decline? A combination of the rise in macroeconomic uncertainty,both domestic and global,since mid-2008,worsened by the heightened regulatory uncertainty and comatose policymaking since late 2010 appears to be the main culprit. And before we go blaming the RBI’s monetary tightening,there is no evidence to suggest that the rise in the cost of capital played any material role. But the lack of funding has been an insidious problem. Corporate savings has been the largest source of funding for firms’ investments. And the decline in corporate investment is mirrored by a similar size gap down in firms’ internal savings which has declined from over 13 per cent of GDP in 2003 to less than 8 per cent of GDP.

Government’s market borrowing,which averaged around 5 per cent of GDP in the early 2000s,was brought down to an average of 3 per cent of GDP over 2004-07. The additional funding space of 2 per cent of GDP helped to lower lending rates and boost investment. But even before the global crisis,government borrowing had begun to rise and the post-Lehman stimulus added to it. Since the crisis,government borrowing has shot up to an average of 6 per cent of GDP. While it is unlikely that corporate investment would have fared much better in the absence of the fiscal stimulus,it is clear that the continued large borrowing by the government is making it more difficult for corporate investment to rebound.

A prerequisite for growth to accelerate in FY13 and for India to return to the 9 per cent growth trajectory is a jumpstart in the private investment cycle. The next few months could be the crucial trigger. The March state election results are likely to determine whether the ruling coalition governs from a position of weakness or strength. The upcoming budget and Parliament session will test the government’s resolve in restarting the reform process and ending the comatose policymaking. If the government delivers on credible fiscal consolidation,releases the binding supply constraints (coal and land),and signals intent on longstanding policy reforms,investor sentiment and the investment cycle could rebound in earnest. If not,then the investment slowdown could turn from a cyclical malaise to a structural malady.

The writer is India chief economist,JP Morgan Chase. Views are personal
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