The economic slowdown is deeper than what has been thought so far. Growth has sunk to an over six-year low of 4.5 per cent in the second quarter of the current financial year, falling well below the psychological 5 per cent mark. The headline number, largely propped up by higher government spending, is well below the RBI’s estimate of 5.3 per cent, signaling the severity of the slowdown. Nominal GDP growth came in at 6.1 per cent, almost half of what was expected in the Union budget. With high frequency indicators suggesting that the slowdown continues unabated — the eight core sectors contracted by 5.8 per cent in October — meeting even the revised RBI target of 6.1 per cent for the full year will be unlikely, despite the base effect kicking in.
Growth in the second quarter was largely driven by higher government spending. Public administration and defence, which is largely government spending, grew by a healthy 11.6 per cent in Q2FY20. Excluding it, gross value added by the economy grew by a mere 3.2 per cent. Manufacturing activity contracted, while construction and trade, hotels, transport and communication weakened further. The prospects going forward aren’t any better. Government spending will come under pressure with its own revenues falling well short of expectations. Its gross tax revenues have grown by a mere 1.2 per cent so far (April to October), while the budget had pegged revenue growth at 18.3 per cent. The stress in government finances is already evident with the fiscal deficit (April to October) standing at 102.4 per cent of the full year target of Rs 7.04 lakh crore. Sticking to the fiscal deficit target would mean cuts in spending, further intensifying the slowdown. However, any deviation, financed by higher borrowings, would lead to a hardening of interest rates, negating the impact of the rate cuts by the Monetary Policy Committee (MPC).
The sharper than expected slowdown restricts the options before the MPC, which meets next week. While retail inflation has inched upwards, largely on the back of higher food prices, given the deviation in growth from its own estimates, the MPC should continue with its loose stance, and opt for bigger rate cuts. On its part, the government has announced a series of measures to arrest the slowdown. But these need to be followed up with quick execution. There is some talk about extending NBFCs a lifeline as was done in 2009. While this would help stimulate credit flow — RBI data attests to the severe slowdown in credit flow in the first half of this year — more needs to be done. Sector specific interventions will alleviate some of the pain, but for steady, and sustainable, growth, the deeper structural issues plaguing the economy need to be addressed.