Economists, of late, have had a tough time predicting India’s GDP growth trajectory. Just when the market was expecting growth to recover post-demonetisation, GDP growth print for Q1FY18 slid below market expectations to 5.7%. This is the lowest quarterly growth in the last three years. Along with this low growth print, two other things warrant attention. In H1-2017, nominal merchandise imports growing by 28%, and the rupee appreciating by over 4% against the US dollar.
First, the GDP numbers. The Q1FY18 growth number of 5.7% definitely reflects a considerable slowdown in economic activity. Industrial growth is at a five-year low, investment activity has failed to pick up, and export growth remains tepid. Services, however, have been buoyant, registering a strong growth of 8.7%, primarily led by trade, hotels, transportation and communication services. Slowdown has been attributed to de-stocking of inventory in the run up to GST and aftermath of demonetisation. IIP and PMI numbers, too, have remained weak. Growth for the first two quarters of 2017 stands at 5.9%.
This brings us to our second observation—the surge in merchandise imports in H1-2017. Major import items that have surged in the first half of 2017 are gold and precious stones, electronic goods, crude and petroleum products, and ores and minerals. However, growth in capital goods imports like machinery and transport equipment has been benign due to weak domestic investment activity. Gold imports surged 121% in H1-2017, accounting for 10% of overall imports in this period. This may be a result of inventory build-up by the jewellers ahead of the GST roll-out. Another possible explanation for this could be that consumers are moving away from bank deposits and real estate towards gold amidst macroeconomic uncertainty. Crude oil imports went up by 42%, making for around 23% of overall imports. Coal and coke imports also surged 60%, accounting for almost 5% of overall imports. Even without including oil, coal, gold, precious stones and capital goods, imports are up 15% in H1-2017, reflecting a broad-based pick-up in imports. This number was 21% in Q1FY18.
Third, the rupee over the same period has appreciated by over 4%. Most of the appreciation of the rupee has been attributed to the dollar’s weakness.
So, how does all of this link up? Recall that GDP is computed using the formula (GDP=C+I+G+X-M), where C stands for (consumption), I (investment), G (government expenditure), X (exports) and M (imports). From the demand side, GDP is defined as the expenditure on domestically-produced goods and services by households, government and private enterprises, including exports. Thus, expenditure on imported goods and services (M) needs to be subtracted to compute GDP.
The demand-side data throws up some interesting observations. In terms of contribution to real GDP growth, while private and government consumption together contributed to over 95% of the growth, the biggest drag to GDP has come from import of goods and services (shaving off 2.8 percentage points). Imports (real terms) increased by 13.4% in Q1FY18, compared to a tepid export growth of 1.2%, and at the same time consumption expenditure grew at a decent pace of 8.5%. Imports excluding gold and precious stones accounted for almost 20% of the total consumption in Q1FY18, as compared to 18% a year ago.
This is worrying because it reflects imported goods being substituted for domestically-produced goods amidst weak domestic industrial activity. Based on historical data, we see a strong correlation between import growth and rupee appreciation. A 4% appreciation in the rupee-dollar rate has led to a surge in nominal merchandise imports by 28% in H1-2017.
Increase in imports could also reflect the overhang of demonetisation. With domestic supply chains rendered broken, firms might have found it easier and cheaper to import goods rather than produce them. Strong import growth is not bad per se when accompanied by robust domestic economic activity. However, when domestic activity remains weak and the manufacturing industry is witnessing a slowdown, it warrants the attention of policy-makers as this means that domestic demand is not being met by domestic production—so much for Make-in-India!
Is this to say that the appreciation of the rupee is hurting growth? The real underlying issue is that India’s growth has been lopsided driven by government and private spending. Private sector investment hasn’t recovered in a sustainable manner for the past two years. Jump-starting the economy through financing growth is also not possible when banks are burdened with NPAs.
According to the latest RBI business expectation survey, businesses face weak pricing power amidst increased input prices and weak demand. The situation is expected to continue in Q2FY18. Overall expectations for Q2FY18 remain weak, lower than Q1FY18. A majority of the respondents don’t expect much of a change in their capacity utilisation. The viscous cycle continues with no broad-based recovery in sight.
On investment side, corporate balance sheets are stressed and fresh investments are not being undertaken. Private investment cycle has failed to pick up despite efforts by the government and rate cuts by RBI. Gross fixed capital formation, as a percentage of GDP, has been declining since 2011—falling from 34.3% in FY12 to 29.5% in FY17—which is worrisome.
The first step towards solving a problem is to acknowledge the real issue. It’s time for some reality check on achhe din!