The Economic Survey said that India has reached a sweet spot. It could finally be launched on a double-digit medium-term growth trajectory. It also stated that “in the short run, growth would receive a boost from lower oil prices”. India has benefited greatly from the recent changes in the global economic environment. Further, this is the major reason for the transformation of India’s external position and the dramatic decline in inflation. But this is only one side of the story. The other negative side effect of the external environment is the prolonged U-shaped bottom in the index of industrial production for manufacturing and the fluctuating fortunes of the corporate sector.
The collapse of the prices of oil, related refined products as well as manufactured items based on them has had a positive effect on the current account deficit (CAD), inflation and the fiscal deficit. But the same global fundamentals that led to the collapse of commodity prices have had a deleterious effect on the world and Indian economies since 2008.
The story starts with the world-trade and GDP-growth boom of the 2000s. This boom, almost a bubble in some respects, went bust because of the global financial crisis, which left in its wake large excess capacities in the tradable sectors of the world economy. World GDP growth, which averaged 3.1-3.2 per cent during the 10-15 years ending 2008, collapsed to 2 per cent for the following seven years.
The nature of the bubble is better captured by the growth of world imports, which accelerated from an average of 5.8 per cent per year in 1999-2003 to 7.8 per cent in 2004-08 and then collapsed to 3 per cent during 2009-13. World gross fixed capital formation (GFCF) grew at an average 5.4 per cent during 2003-07, more than double the 2.5 per cent of the previous five years. As in most recessions in the West, the globalised corporate sector tightened its belt and improved efficiency, preserving, and in some countries even increasing, profitability.
The corrective worldwide fiscal stimulus and monetary easing that followed led to a quick recovery in the developing economies. But it had some effects that weren’t necessarily beneficial for all countries because of the short-term focus and mistiming of policies. Many developed countries switched from a relaxed fiscal policy to a contractionary one in 2010, instead of correcting the weak demand-excess capacity problem in tradable goods and services. This put an extra burden on developed-country central banks at a time when monetary policy was already constrained by near-zero interest rates. The commodity boom/ bubble revived quickly after the temporary collapse at the end of 2008 and continued for several years, even after the slowdown in world GDP and trade growth. It was finally pricked in 2014 after a credible announcement of an end to the US Fed’s quantitative easing (QE) programme.
Some large emerging economies compounded the global excess-capacity problem by continued investments through large, risky injections of policy-directed credit or expansionary fiscal policy. For instance, the rate of growth of China’s GFCF declined only marginally from 13.4 per cent per year during 2002-07 to 12 per cent between 2008-13, while overall world GFCF collapsed from 4.6 to 1.8 per cent. Consequently, the excess capacity in tradable goods and services did not reduce and, in fact, worsened for some products. This low demand and excess capacity meant fewer or no opportunities for private capital in developed countries, driving it into commodity markets.
The negative effects of the global demand deficit and excess capacity have affected different countries to different degrees. The export-oriented economies of China, East and Southeast Asia have been most severely affected. India, an export-neutral economy, has been impacted less. But India is a dual economy and a substantial part of its corporate sector is globalised. A sub-index for this globalised sector, derived from the IIP for manufacturing, was in the last quarter of 2014 still below the level it was at in the first quarter of 2011. Its average growth rate during the last four years was minus 0.3 per cent, compared with 3.1 per cent for the non-globalised IIP sub-index and 6.7 per cent for the IIP for electricity. Part of the corporate sector and most of the non-corporate economy remains relatively isolated from global cross currents, as suggested by the robust growth of electricity supply. The vehicle sector, which is somewhat shielded from global pressures, shows signs of sustained recovery, despite the negative effect of rising real interest rates during 2014-15. The recovery of growth of private consumption (5.2, 6.2, 7.1 per cent), GFCF ( minus 0.3, 3, 4.1 per cent) and GDP (5.1, 6.9, 7.1 per cent) in 2012-13, 2013-14 and 2014-15 is, therefore, consistent with the dual nature of the Indian economy.
One implication of the negative effect of the external environment on the corporate sector is the slower recovery in tax revenues. The corporate sector contributes tax revenues, not just directly as corporate income tax, but also through the income taxes paid by its employees and excise taxes.
This negative revenue effect of the external recession has offset some of the positive effects of the reduction in oil-related subsidies on the fiscal deficit.
The external environment has, therefore, had both a positive and negative effect on the Indian economy. The negative effects of the global recession were felt immediately but were masked by the temporary bubble created in India in 2010-11 through directed credit to PPP infrastructure contractors. These negative effects were felt again after the pricking of the local Indian bubble. The positive effects of the recession on commodity prices were delayed because of the global monetary expansion but started to be felt in 2013-14, with the prospective end of the Fed’s QE. Further, the negative effects on the globalised sector have been magnified whenever the rupee appreciated in real effective exchange rate (REER) terms. Between September 2013 and April 2015, the REER appreciated by 11.4 per cent.
On balance, the effect of external factors on the Indian economy in 2014-15 has been positive on the current account, mildly positive on the fiscal account and negative on corporate growth. The net overall effect is positive, but not as large as most analysts have assumed.
The writer is mentor (public policy and economics), FICCI