A general opinion about the state of the Indian economy is that growth is picking up. Capital investments are seen reviving, albeit very slowly. Recent information about robust growth in indirect tax revenues in the first quarter of 2015-16 lends further credence to this view. Yet the ‘green shoots’ hypothesis appears premature when reading the signals given by different lead indicators, some of which continue to flounder. A set of four charts argues why.
The capital investment revival is underpinned by the steady upturn in capital goods’ output growth production of past several months. But it is hard to conclude that this tendency is sustainable. Production growth peaks in this volatile component are not just progressively lower, but also falling since January this year with a sharp collapse in May to just 1.8%. At 4.4% so far (April-May) this fiscal year, growth in capital goods’ output is half that in the similar period last year (8.6%). That core industries’ growth has been tapering off since November last year, except for the 4.4% growth in May 2015 further queries capex revival. Moreover, listed companies do not expect substantially better earnings and profits growth in April-June 2015 compared to the March 2015 quarter, which in itself was a two-year low.
Could this be yet another false start? A repeat of the stop-start-stop pattern observed from 2011? Doubts about unsustainability are supported by the sharp drop in merchandise exports growth, with which growth in capital goods’ output closely moves; export growth is also a good predictor of capital goods’ trends with a 2-3 month lead. The absence of a sustained domestic demand impulse, e.g. sales of consumer goods, passenger cars, etc. further questions a robust continual. Last, but not the least, is the falling demand for bank credit across all industry segments—large, medium and small (see Chart 1). A gradual recovery story needs a more solid foundation than so far available.
Chart 2 offers further reasons as to why the investment cycle is not yet ripe for a restart and why the economy might not even be on the mend as current beliefs uphold. By far the best predictor of fresh investment spending is the utilisation rate of existing production capacities. As per the RBI’s quarterly Order Books, Inventories and Capacity Utilisation Survey (OBICUS) up to October-December 2014, the slack in manufacturing capacities is progressively increasing. These show a sustained, discrete fall persisting into the third quarter of FY15. It is not yet known whether utilisation rates increased in the current year, but corporate earnings and profit growth offer reasonable clues. These certainly do not encourage belief that production capacities are getting used up!
Bank credit growth, which is a reliable indicator of working capital requirements of businesses, is steadily falling in correspondence with capacity utilisation rates. Were industrial production on the rise, i.e., lesser slack in existing capacities, there should be a pick-up in bank credit, which is adjusted for the steep price declines in petroleum products. Further, the argument that the fall in bank credit growth is made up for by the increased use of non-bank funds doesn’t hold where working capital needs are concerned as no firm will issue bonds (long-term capital) for the purpose, while external commercial borrowings are unavailable for short-term financing. Moreover, issue of commercial paper for short-term funding needs is confined to large firms; banks typically do not subscribe to any such issues by small and medium-sized firms.
Chart 3 shows the waning external impulse in its broadest range, i.e., exports of goods and services. Growth of merchandise exports, excluding that of petroleum products, peaked in November last year; for the last six months, these are in contraction mode, which is deepening. Services’ exports, a long-time mainstay of current account balances, have tapered off in the last six months too, following merchandise exports into negative territory from March-April 2015. With the initial world output growth forecasts for 2015 already scaled down by several international agencies, most recently by the IMF, there is little scope for any kick from this quarter. Earlier, RBI’s growth outlook had already emphasised that India’s growth will be predicated upon domestic demand for the current year. What is more worrying is that the contraction in merchandise exports is approaching its severest in the last three years, raising serious questions about the reasons why. Then again, it is worthwhile noting that export growth hasn’t sustained for long since 2012—contractions have inevitably followed export growth pick-up quite quickly, and growth trends are downward since 2013.
All of the above information is centered on industry, or 18%of the economy’s production base, whereas the dominating component here is of services (55%). Some insight into the recovery path of this segment is available from the forward-looking, surveys-based Purchasing Managers’ Index for services. Chart 4 plots the PMI-Services for the month of June, along with bank credit to the services sector with a three-month lead. The startling bit of course, is the slippage of services into contraction zone (values below 50) from April 2015, or in the current financial year. The index for services is down an average 1.8 points in the April-June 2015 quarter, relative to similar period in 2014-15 and is below the long-term average level of 51.4 (April 2012-June 2015). It is the services sector slowdown that is the most worrying. Considering that 55% of India’s entire production base is contracting, how optimistic or sure can one be that growth is picking up and investments reviving? So far, the evidence just isn’t compelling enough. Ringing early bells of recovery could then be misleading.
The author is a New Delhi-based macroeconomist