India’s growth story at crossroads

India’s growth may be showing signs of steady recovery but the mid-year economic review tabled in the Parliament clearly indicate that there is a degree of uncertainty in the economy. Clearly the economy is sending mixed signals with different indicators not always pointing in the same positive direction. In view of these challenges, the review tabled by Finance Minister Arun Jaitley said real GDP, therefore, projected to be between 7-7.5 per cent with CPI inflation with the RBI target of about 6 per cent.

There are two reasons for these mixed signals. One is that the pace and strength of economic recovery is unusually difficult; and secondly, the GDP data can be subject to a degree of uncertainly because of large changes in relative prices in the economy.

The striking fact, according to the mid-year economic review, is that the wedge between CPI inflation and WPI inflation has been rising steadily and reached an unprecedented high of 8.5 percentage points in the second quarter of this financial year. This creates complications in measuring the GDP. This, however, does not mean the GDP estimates are “flawed or biased”. But the GDP estimates may be prone to measurement uncertainty because of the possibility of inappropriate price deflators being used to derive real gross value.

An economic metric that accounts for inflation by converting output measured at current prices into constant-dollar GDP is called a price deflator. The GDP deflator shows how much a change in the base year’s GDP relies upon changes in the price level It is also known as the “GDP implicit price deflator.”

The second source of potential measurement error related to the use of volume indicators as proxies for real value added growth. In that case the increasing production efficiencies as suggested by manufacturing data may underestimate the real value added growth.

This data measurement uncertainly in real GDP estimates may not be systematic or biased but certainly gave mixed signals on India’s economic growth story this year and is sometimes “puzzling”, the review said.

This explains the fact that India’s tax collections this year have been buoyant relative to the growth. Here, too, indirect taxes have fared better than direct taxes probably because corporate profits have not been buoyant, reflecting slowing nominal GDP growth. Nominal GDP growth is real GDP growth plus inflation. With inflation slowing down, the nominal GDP, a critical factor in growth of taxes, too was slowing down.

The mid-year review also points out another serious problem in the economy. The overall picture masks significant variation. It says the break up of the credit figures shows that the real consumer credit has picked up rapidly while industrial credit has slowed dramatically. So much of the credit to industry may have been to stressed sectors, raising the possibility that loans are provided for balance sheet purposes rather than to finance new activity.

Sectorally, too, there are mixed signals. While the overall Index of Industrial Production (IIP) has grown marginally faster in the first six months of this financial year 2015-16, there is considerable variation in performance across sectors. Power, fertilisers, and cars have been surging but commodities like steel, iron, aluminum, and cement are not doing that well. Growth in capital goods imports, which partially proxies for investment, has decelerated from about 12 per cent in April 2015 to barely positive territory.

Strikingly, the Indian economy this year is powered by private consumption and government investment unlike in the past particularly during the boom years when the economy was powered by by private investment and exports as well. With balance sheets highly stressed, private investment, particularly that of the corporate is very weak now. Going forward, these two areas of concern needed to be addressed.

The data uncertainty and mixed signals sent by the economy suggests that more attention should be paid to the demand of the economy, the mid-year review said additionally, the sharp and continuing decline in nominal GDP growth, as well as the fact that the economy is powered only by private consumption and public investment is a cause for concern.

The declining nominal GDP growth and the challenges to the outlook for real GDP growth questions the appropriate role for fiscal and monetary policy implying some hard decisions would have to be taken in the forthcoming general budget and the monetary policy needs to encourage growth while keeping inflation under check.

Coupled with this is fiscal outlook, which looks challenging in face of seventh pay commission recommendations, expected to add 0.65 per cent of GDP to expenditure. Also there will be pension burden and more expenditure on public investment to kick-start the economy with private investment still weak.

If one reads between the lines, with what has been said in the mid-year economic review, the picture is not all that rosy on the economic front. And it is very clear that uptick in growth does not necessarily mean that the second quarter indicate pickup or green shoots in the economy.