Indian gross domestic product (GDP) data seems to have become a constantly evolving puzzle. In February 2015, Ruchir Sharma, Managing Director and Head of Emerging Market Strategy, Morgan Stanley Investment Management, wrote, “the dramatic upward revision of the GDP growth rate is a bad joke, smashing India’s credibility and making its statistics bureau a laughing stock in global financial circles” and “Nobody really believes that the Indian economy grew at anywhere close to 7 per cent last year, and shockingly no one is willing to put an end to this nonsense.” I disagree strongly.
In my view, more than 90 per cent of the world renowned analysts have failed to understand the global financial crisis and its impact on the world economy. The financial crisis is not just another post-war recession or “great recession.” It is a once in a three or four century event and the most significant since the Great Depression. It has changed the nature of many effects and correlations, at least temporarily. Non-recognition of this fact has led to inadequate or wrong policies that have delayed the global recovery. This note focuses on the Indian economy as well as the relations between the Indian corporate sector and the overall economy.
Since 2013-14, Indian GDP growth has been on a gradually rising trend. From about 6.9 per cent to about 7.3 per cent over 9 quarters. The latest data for the first quarter of 2015-16 at 7 per cent (y-o-y) is below this two-year trend. But two demand-side drivers of sustained recovery were above their trend lines in the first quarter. Private consumption growth has increased from about 6.0 per cent to about 6.7 per cent and was at 7.4 per cent in the first quarter — significantly above the trend. Fixed investment growth, which has been virtually flat at 4 per cent, grew at 4.9 per cent (y-o-y), significantly higher than in the last eight quarters.
These two factors give confidence that the GDP will remain on trend for the rest of the year giving us a growth rate between 7.5 per cent to 8 per cent for the year 2015-16. Foreign trade is an area of concern as export growth has been negative for the past four quarters and the reduction in imports due to falling commodity prices may be exhausted by the end of the year. Thus declining net exports could act as a drag on the economy. As I had warned in ‘Inside, outside’ (The Indian Express, June 6), the external environment remains a drag on corporate investment and growth recovery.
The opening up of the Indian economy in the 1990s forced the Indian corporate entities to compete and become stronger by building world-scale plants and quality products. Corporate investment and growth, therefore, led the India growth story in the 2000s and were highly co-related with it.
The global financial crisis has disturbed this co-relation, aided by the misplaced notions of fiscal austerity. Non-market economy China, given its export- and investment-led growth model (with 45 per cent-plus investment rates), continued to build new capacity in tradable goods unmindful of the declining profitability. The consequent excess capacity put increased pressure on the profits and reinvestment of the globalised Indian corporate sector, once the fiscal-monetary-ECB (European Central Bank) bubble of 2010-11 was pricked and the profit enhancing efficiency improvements were exhausted around 2012-13. Thus, the cyclical investment recovery that most analysts expected by 2013-14 has been delayed further.
Though the recovery of the globalised part of the corporate sector during 2015-16 is likely to depend on the strength of the US economic recovery, other parts of the sector are more intimately related to domestic policy. The shift in fiscal policy from consumption and transfers to infrastructure investment will increase the fiscal multiplier and raise demand for both infrastructure companies and consumer durable companies. The acceleration of fixed investment growth in the first quarter and the above trend growth of 6.9 per cent of the construction sector are suggestive. Falling inflation has raised real interest rates and thus tightened monetary policy. Restoring the real interest rate to a level that accounts for a projected end-year consumer price index (CPI) inflation of less than 5.5 per cent will remove policy constraints on the growth of interest-sensitive sectors like automobiles and real estate, thus stimulating durables investment and growth.
The efforts to reduce “tax terrorism” have smacked of two steps forward one step backward, undermining the credibility of government. The increase in paperwork linked to the black money bill or the misuse of its draconian powers could erode credibility further. The government must ensure that on both the tax front and ease of doing business the changes reach down to the ground level where the vast majority of businesses (tiny, small and medium) operate. This will give greater confidence to all business, including corporate and foreign direct investors, to accelerate investment plans.
Recent developments in China were a shock to those who believed that the Chinese Communist Party-led economy is a market economy like any of a hundred others. It was not a surprise to those analysts who have been predicting a growth slowdown based on long-term trends and/ or knew the medium-term dangers of creating a credit-fuelled investment bubble. However, even those who have been watching for signs of economic slowdown (excess capacity in manufacturing and real estate) below the officially revealed growth rate of 7 per cent were surprised by the quality of economic management displayed in the creation and pricking of the China stock market bubble. This loss of invincibility will have a more lasting impact than any short-term turmoil and uncertainty created by it and the subsequent yuan devaluation.
In the short term, we need to watch out for dumping by stressed Chinese firms, ensure that our real effective exchange rate does not appreciate and stick to our revenue deficit targets to minimise vulnerability to shifts in capital inflows and outflows. In the longer term, a decline in China’s growth and investment will reduce excess capacity in manufacturing and benefit India. But we will benefit only if we pursue our reforms more effectively.
The writer, a former executive director at the IMF, is an economic and public policy mentor.