Chickens come home to roost

How badly has growth been affected?

GDP trends show that growth has steadily declined in the last five quarters, slowing from a peak level of 9.4% in the fourth quarter of 2009-10, when RBI started moving up the policy rates, to 7.7% in the first quarter of 2011-12, a decline of 1.7 percentage points.

However, the impact of the slowdown has been highly skewed, with the three major sectors?agriculture, industry and services?showing very disparate trends. Although, things are encouraging on the agriculture front. During the slowdown, over the last five quarters, agriculture has grown at an average rate of 5%, which is well above the trend rate of growth in the sector. Consequently, the foodgrain stock in the beginning of September 2011 was 56.4 million tonnes, which included 22.7 million tonnes of rice and 33.6 million tonnes of wheat.

In the case of industry, the scenario is the opposite. Growth in the first quarter of 2011-12 was 5.1%, which is 7.3 percentage points lower than the peak rate of 12.4% achieved in the fourth quarter of 2009-10. And there is still no end in sight, with industrial growth decelerating by one percentage point in each of the last three quarters. Thus, the contribution of industry to overall GDP growth has halved from 37.3% in the last quarter of 2009-10 to just 18.4% in the most recent quarter. The slowdown in industry was extensive, covering the manufacturing, construction and mining & quarrying sectors where the deceleration has been faster than that of industry as a whole. The consolation is the improvement on the electricity front, where growth has more than doubled to 7.9% over the last four quarters.

Surprisingly, the sharp slowdown in industry has hardly had any impact on the services sector. Growth was a substantial 10% in the first quarter of the current fiscal year, just a few decimal points below the peak rates achieved at the start of the slowdown. And the contribution of the services sector to growth has shot up from less than two-thirds at the start of the slowdown to more than three-fourths of the overall growth now. In services, trade, hotels, transport and communication have been the most buoyant segments with growth touching 12.8%, the highest ever recorded.

What about the external sector?

Here also the record has been mixed. On the export side, merchandise exports grew by 50% in the first four months of the fiscal year, a substantial achievement considering that merchandise exports registered a significant 37.4% growth in 2010-11. And despite the slowdown there has been no let up in imports. Overall, imports grew by 40% and non-oil imports by a faster 48% in the first four months of the current year. But the lower growth in the global economy may take some of the sheen off exports.

In the case of capital flows, the trends are not uniform. Foreign direct investments, which slowed down from $37.8 billion in 2009-10 to $30.4 billion in 2010-11, buoyed up to $14.5 billion in the first four months of 2011-12. But most recent monthly data show a sharp deceleration, from $5.76 billion in June to $1.1 billion in July. Portfolio flows have also been subdued with the numbers falling from $31.5 billion in 2010-11 to $4.3 billion in the first four months of the year.

What are the other major issues?

The single most important problem is inflation. Although policy rates have been increased a dozen times since March 2010, the wholesale price increase has remained above 9% for the last few months, touching 9.78% in August 2011. While food prices are now climbing up, at 9.62%, prices of manufactured goods are rising at 7.8% and prices of fuel at 12.8%.

Why is inflation stubbornly high despite the large food stocks?

Inflation has been on a high in all the emerging market economies even as the industrialised countries are facing stagnation. The chief economic advisor, Kaushik Basu, refers to this global phenomenon as salad-bowl inflation. He points out that liquidity easing and monetary expansion in the advanced economies has caused larger capital flows into the developing countries and added to the inflationary pressures. He believes that the trends are likely to persist for some time. In his view, only a higher degree of coordination in policies pertaining to macroeconomic demand management across nations will help contain the inflationary pressures. However, collective global action is no easy task as the understanding of the complex economic processes and inter-linkages is still rather limited.

Basu is quite optimistic about trying out more unconventional ideas. Pointing out the example of Turkey, he notes that the country lowered interest rates, which stimulated production, and helped lower inflation rate.

What are the prospects of a pick up?

The trends so far are not very encouraging. The most recent IIP trends show that the demand for capital goods slumped by 15.2% in July 2011, the most recent month for which data is available. Consumer demand seems to be picking up in a limited way. National accounts data shows that gross fixed capital investment in the first quarter of 2011-12 was only 28.4% of GDP, which is 6.3 percentage points below the peak of 34.7% of GDP achieved in the second quarter of 2008-09. And there are still no signs of a reversal in trends. In fact, RBI estimates on corporate investments even indicate slower growth.

Many believe that the policy rate increases will be eased soon. But with rising oil prices and the falling rupee increasing the fuel prices (and also that of other imports), containing inflation will remain a tough task, at least for some more time. And the growing political uncertainty in recent months, with Parliament unable to push through legislation at a faster pace and the growing infighting within the government, also puts a big question mark on the government?s ability to take tough decisions. Pushing through the land acquisition and rehabilitation bills is a major issue that needs top priority. The government needs to reassure industry of fair play in the current war of attrition regarding claims to natural resources. The reforms in governance have failed to keep pace with the growing aspirations.