Reasons for slow GDP growth rate & associated factors

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 quarters 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.

What accounts for the decline in growth rate by almost

2 percentage points?

The slower growth is due to the decline in inventories ahead of the rollout of GST combined with the Demonetisation exercise.

The rate has come down predominantly due to pre- GST effect as manufacturers were focusing more on clearing the existing stock.

Chief statistician of India said rising cost of intermediate goods and inventory deaccumulation in anticipation of GST implementation led to manufacturing growth falling sharply.

Though he expects a revival in the second and third quarters as manufacturers normalize their stock positions subject to how well they have integrated with GST.

The most disappointing aspect of the first quarter numbers is the steep fall in the growth rate of manufacturing to 1.2%.

Because of the good monsoon, agriculture will do better. Since agricultural growth rate last year was also good, the increase may not be that much.

Sharp decline in growth rate noted in the last few quarters cannot be attributed to poor export performance.

Growth is fuelled broadly by two types of demand, domestic and external.

High export growth has propelled the growth rate of many countries, including China’s. In India’s own experience, the high growth phase between 2005-06 and 2007-08 saw exports growing at an average annual rate exceeding 20%.

India’s declining growth rate has also coincided with poor export performance. Export demand has been weak because of the tepid growth rate of the advanced economies.

Both in 2014-15 and 2015-16, the export growth rate was negative. However, the export growth rate has become positive since the second half of 2016-17.

While undoubtedly export demand is critically important to sustain high growth, the sharp decline in growth rate noted in the last few quarters cannot be attributed to poor export performance. In fact, as compared to the previous year, the export performance has improved.

Demonetization and GST contributes for slow down of growth

Interestingly, both the Government and the opposition parties have used last November’s demonetisation decision and the arrival of the GST system as a backdrop for the slowdown of growth, and both acknowledge that the two measures have had an enormous disruptive impact.

With reports that 99 per cent of demonetised currency has returned to the banks, the Opposition is demanding to know where the black money component was, especially given that the Government had projected demonetisation as a frontal assault to flush out unaccounted wealth.

More importantly, critics of the Modi regime point to the ‘damage’ that demonetisation has done to India’s economic growth — and without the resultant benefits the Government had claimed would accrue to offset the ‘temporary’ setback.

The opposition parties have also accused the Centre of rushing into the GST regime without proper planning, and driving the economy to the edge.

However, the Government has maintained that GST will turn out to be a huge plus factor in driving economic growth once the system settles down to a near glitch-free performance.

On demonetisation, it has argued that massive amounts of hitherto unknown monies have joined the country’s banking system — which in itself is a big achievement. Besides, the inflow of funds has not just helped the banking sector but will also assist the tax authorities to trace questionable deposits in the months to come.

In a related development, the Union Ministry of Finance has cracked down on 200,000 dormant companies, some of them suspected of money laundering and stock price manipulation.

The Government has acknowledged the disruptive nature of both GST and demonetisation, but added that their adverse impact on economic growth was a short-term phenomenon.

Incidentally, this view has been seconded by various economic experts, ranging from those at the World Bank, the International Monetary Fund, global credit rating agencies and commentators from within the country.

There is no doubt that demonetisation and GST have contributed to the slowdown of GDP growth, but it would perhaps be an exaggeration to hold them entirely responsible, or believe they are the key factors.

The first full quarter after demonetisation was that of January-March 2017, and it was the period when the effects of the decision ought to have been at its worst.

Yet, GDP growth remained healthy, and was actually at a decent 6.1 per cent in the quarter ending March 2017; it wasn’t bad in October-December 2016 either.

The fallout must have waned by the April-June quarter, and, therefore, the blame lies not at demonetisation’s doors. Similarly, pre-GST disruptions, although admittedly serious, could not have been so impactful that they should drag the GDP growth so far down.

Besides, one must not lose sight of the fact that the growth rate has been going down for the past six consecutive quarters — in March 2016 ending, it was 9.2 per cent; and then it went on a downward spiral to 7.9 per cent, 7.5 per cent, seven per cent, 6.1 per cent — and now 5.7 per cent. Clearly, there had to be other explanations, and finding scapegoats in demonetisation and GST makes no sense for either the Government or the Opposition.

Manufacturing is lagging

Undeniably, the manufacturing sector, apart from crore infrastructure, has the greatest potential for large-scale employment generation.

Unfortunately, manufacturing is also the laggard in present times.

The manufacturing sector growth at 1.2 per cent is the lowest in the last five years, and this is largely because private investments have failed to pick steam despite the Government’s various flagship programmes.

The fall in the investment ratio over the last decade can be partly attributed to the global financial crisis of 2008. The ratio shows a steep fall from 38 per cent in 2007 to around 30 per cent towards the end of 2016.

Private investment declined 19.2 per cent in 2011-12 to 16.8 per cent in 2014-15.

Corporate sector investments dipped from 16 per cent to around 10 per cent in 2016.

This has been attributed to increasing debt burden and a slowdown in private credit due to stressed assets in banks etc.

These in turn have led to an increase in stalled projects — though it must be emphasised that projects were also stalled due to bureaucratic delays and other reasons such as non-availability of land and payment issues.

Whatever the reasons, the delays in completion accounted for six to seven per cent of the GDP and crippled the growth momentum.

Impact of Index of Industrial Production

The Index of Industrial Production (IIP) data also tell a story. According to the Central Statistics Office, the cumulative industrial growth during April 2016-February 2017, as compared to the corresponding period of the previous year, was 0.4 per cent.

Fifteen out of 22 industry groups in the manufacturing sector showed negative growth during February 2017, as compared to the same month of 2016.

It is, then, obvious that the manufacturing sector, hobbled by lack of private investment, has failed to click. Equally obvious is the fact that the Government’s various measures and its repeated appeals for private investments, have not worked.

The private sector’s attitude is baffling.

The Government has gone a long way in addressing many of its concerns.

It has reduced red tape, streamlined rules and regulations for business, brought in the bankruptcy code, done away with quite a few of the archaic laws that stifled industry, and in general created an investor-friendly environment.

True, there are issues still, one prominent among them being the unchanged labour laws.

But there has never been an ideal situation and there never will be, for private investment.

Over the last decade, however, this is the best time, and yet the private industry has simply not shown the zeal to seize the moment.

Exports sluggish

If private manufacturing has been sluggish, the export sector’s performance too has been dismal, and this has contributed to low GDP growth in some ways.

It’s not a coincidence that over the last decade and half or so, a high GDP growth came alongside booming exports. The near eight per cent growth during 2003-11 was complemented with a 20 per cent growth in exports.

Exports were close to $319 billion in 2013-14; they were down to $274 billion (and this was an ‘improved’ figure as compared to 2014-15).

It can be argued that export statistics are dependent almost entirely on the state of the world economy and also on the currency rates.

The 2008 crisis, starting with the subprime issue in the United States of America and spreading across the globe, chipped off many millions of dollars from exports of many nations, India included.

It has taken almost a decade for the global economy to find its feet again, but it remains to be seen whether India can quickly enough do so.

On the currency matter, it must be accepted that the real effective exchange rate (REER), which is the exchange rate after adjusting for inflation, has seen a sharp rise over the years, thus rendering exports uncompetitive.

The rise in the REER index has coincided with the sharp drop in export revenues.

That said, it would be naive to believe that exports have done less than expected merely on grounds of global economic downslide and rising REER.

There are other factors as well, including the uncompetitive costs of production and accompanying logistics (freight rates, for instance).

Given the situation, there is clamour from the Opposition camp that the Government must course-correct. This is true, but the course-correction must not be in the direction which the critics want the regime to take.

Straying from the reform path would be bad, and returning to the so-called socialist economy would be disastrous.

There is a lot that the Government must push for — a new land acquisition law and comprehensive labour law reforms, for instance.

Additionally, it should continue to work on ease of doing business by further simplifying rules without diluting accountability.

The Government must resolve the banking sector’s non-performing assets conundrum.

And, since incremental measures haven’t had the desired impact, perhaps it’s time for some bold and out-of-the-box solutions.

fundamental problem has been the sharp fall in the investment rate

GFCF(Gross fixed capital formation) is a measure of gross net investment (acquisitions less disposals) in fixed capital assets by enterprises, government and households within the domestic economy, during an accounting period such as a quarter or a year.

In India, Gross fixed capital formation rate stood at 34.3% in 2011-12.

This started falling steadily and touched 29.3% in 2015-16. It fell further to 27.1% in 2016-17.

According to the latest numbers, in the first quarter of 2017-18, it stood at 27.5%.

Since the public investment rate has not shown any decline (it stands at 7.5% of GDP), it is the decline in private investment, both corporate and households, that has been responsible for the steady fall.

While the fall in corporate investment is steep compared to what was achieved in 2007-08, it has more or less stabilised at a lower level of around 13%.

Household investment has continued to decline even in recent years. Household here includes not only pure households but also unincorporated enterprises.

Declining growth rate and its effect on employment

Jobless growth is an economic phenomenon in which a macro economy experiences growth while maintaining or decreasing its level of employment.

Deep concerns have been expressed about the fact that the growth that we have seen in recent years has not resulted in an increase in employment.

It may be noted that data on employment are not very reliable. Firm data are available only for the organised sector.

The rest are estimated through surveys. In fact, in the case of unorganised sectors, very often the position is one of ‘underemployment’ rather than unemployment.

Growth can occur because of two reasons. One, it results from better utilisation of existing capacity. Two, it can come out of new investment.

Whatever growth we have been seeing recently has come out of better utilisation of capacity rather than new investment. It is real growth spurred by new investment that generates more jobs.

Falling investment rate

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.

Another interesting factor about the falling investment rate is that the last few years have shown a steady and substantial increase in foreign direct investment (FDI).

FDI inflows in 2016-17 were at an all-time peak of $60 billion. In the first quarter of 2017, the inflows were $10.9 billion.

With this type of inflow and if the investment rate has not grown, the one inference that one can make is that much of the FDI has gone into acquiring old assets rather than going to Greenfield projects. All this implies is that domestic investors continue to remain shy.

What can be done to stimulate private investment?

First, in creating an appropriate investment climate, reforms play an important role. Some of the noteworthy changes that have happened in the last few years are the passing of the bankruptcy code and GST legislation, and modifications in FDI rules. We must continue with the reform agenda and there is still a lot to be done in the area of governance.

Second, financing investment has taken a beating because of the poor health of banks. Banks in India today are universal banks providing both short-term and long-term credit. The sharp reduction in the flow of new credit has also put prospective investors in a difficult situation. To resolve the non-performing asset (NPA) problem and to bring banks back to good health, recapitalisation has become urgent.

Third, a close look must be taken at stalled projects to see what can be done to revive those which are viable. This must be part of an overall effort to hold consultations in small groups with investors to understand and overcome the obstacles that come in the way of new investment. Industry-by-industry consultations and analyses are needed to pinpoint problems and their solutions.

Fourth, even though the progress of small and medium industries is very much dependent on the fortunes of the large, a separate look at medium and small enterprises may be needed to prod them into new investment.

Way Forward

It should not be too difficult for the Government to fix the problem because it has the intent, the talent and the right direction.

Besides, India’s economic fundamentals are robust — inflation is hovering at about two per cent or less; trade and fiscal deficits are within manageable limits; foreign direct investment is at a high; domestic lending rates are down (though there is scope for more cuts and it’s a call which the Reserve Bank of India must take); and the Centre appears determined to tackle the non-performing assets issue plaguing largely the public sector banks.

In other words, there is room for the Government to take bold initiatives to bring the GDP growth back on track.

It needs to provide an immediate stimulus in targeted areas that result in both growth and employment.

The latter is important from the Government’s perspective, given that it has faced accusations for failing to have triggered job growth.

Conflicting figures have compounded the issue.

According to data presented in the Lok Sabha in February this year, the country’s unemployment rate was 3.7 per cent.

But a senior Minister, on the same day as the figures were made available in that House, said in the Rajya Sabha that the unemployment figure was five per cent — and rising.

But of course the issue of unemployment is an old one and it would be unfair to hold the incumbent regime responsible for the mess.

According to a Kotak Securities report, just seven million jobs had been created annually over the last 30 years, whereas the country needed 23 million jobs annually.

Yet, there is no escaping the fact that the Modi Government, having promised to turn around the scenario, has to deliver more.

It could revisit some of its initiatives, such as the Mudra scheme, which is designed to provide self-employment and resultant direct and indirect employment.

Conclusion

The growth rate in 2017-18 is unlikely to exceed 6.5%. Perhaps in the coming quarters we may see a rebound.

Once the glitches and fears of the GST are over, the growth rate may pick up.

Our goal must be to achieve and sustain a growth rate of 8% and above over an extended period and what we need is an immediate stimulus to re-inject the momentum.

That will crucially depend on a big pick-up in manufacturing and private investment spending.

However, there has been a slight pick-up in public investment recently.

That is not enough. Only when the two engines of public and private investment function at full throttle will India fly high.

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.

It’s easy for a Government with a dominant majority in the Lok Sabha to become complacent and populist, especially when polls are two years away.

But it’s also easy for such a regime to bite the bullet. The Modi dispensation must remember that the people have backed it on bold decisions such as demonetisation, and there is no reason why they will not do so again, if strong and non-populist measures are taken to enhance growth and employment.

By Gudipati Rajendera Kumar