Slowing consumption could be the new headwind; on the supply-side, agriculture’s weather dependency persists, construction is yet to revive
The July-September GDP data released last week showed both GVA and GDP rising, 6.1% and 6.3% y-o-y respectively. The re-entry into the 6%-zone marks the end of a five-quarter long growth decline. Dubbed as early sign of growth revival—driven by non-farm, non-government activities, core GDP gained more momentum at 6.8%, building on its 5.5% and 3.8% pace of the preceding two quarters. The key highlight is the rebound of manufacturing—at 7% y-o-y, it added 1.28 percentage points to GVA. Most think the economy has shaken off demonetisation and GST effects, growth will steadily climb upwards and, by the next financial year, it will revert to a 7%-plus path. To be sure, the previous year’s low base may well lift GDP beyond 7% in the next two quarters. But that would be a statistical artefact; the overall growth in FY18 could still be 6.5-6.7%, a tad slower than 7.1% growth in FY17. The bet is still on if growth will accelerate further in FY19 into 7%-plus zone, as many project. The revival in September quarter is largely a supply-side story—attributed to restocking, post-transition to GST, and normalisation of cash, post-demonetisation. There are still opinions that believe it is too early to derive any such conclusion; these estimates are based on the larger formal sector. We still do not know the extent of damages to the informal sector, post-demonetisation, and to those small and marginal units badly affected by GST implementation. These are undeniable facts, and we would have to wait until more data is available with CSO to tell us the real story.
But our focus is on the demand-side where the emerging trend is not reassuring. In particular, private final consumption expenditure (PFCE) and government final consumption expenditure (GFCE) have slowed down considerably, as written about in these columns a while ago (goo.gl/48WRp8). We had argued that higher growth in FY15 and FY16 was mostly driven by the large positive terms of trade shock that began fading in FY17; further, falling investment could have lowered growth potential as well as slowing consumption that could get trapped into a loop in the absence monetary and fiscal policy intervention. Private consumption demand (real), which essentially drove growth in the last two years, has steadily slowed since Q1FY17 (see accompanying graphic). Government consumption, which too propped growth alongside, is slowing as well—fiscal constraints pinching harder with moderating revenues and the need to adhere to the committed fiscal consolidation path. What are the prospects for consumption revival ahead? The benign price environment, especially of oil and commodities, which characterised the late 2014-2016 period, has ended. International oil prices are 28% higher over a year ago, metal prices are up 12%; the Economist’s commodity-price index is 20% higher from its seven-year low in January 2016. Imported cost pressures are already building up as evident in faster increases in input costs in recent months. If the economy’s potential growth is much lower than the consensus, then the output gap could close much faster, adding further pressure upon core inflation. Core inflationary momentum, it must be noted, has steadily risen in the past few months and could very well move closer to the upper bound of the inflation target, 6%, higher than consensus, and thus, reducing the space for monetary policy support or even reversal, dampening consumption. Could investment revive to offset the anticipated slowdown in consumption? Gross fixed capital formation is still very weak despite an uptick; insufficient to prevent its further fall as portion of GDP (nearly a percentage point) in July-September quarter. The NPA repair and resolution will take a while, spare capacity is still abundant; despite the manufacturing rebound, industrial output growth is less than half (2.5%) in April-September 2017 compared to last year (5.8%). With consumer spending slowing too, prospects of investments turning the corner do not appear optimistic. The external demand environment is however brighter. The world economy is seeing a synchronised upturn for the first time after the crisis. But there are uncertainties about its endurance and several challenges, including from normalising monetary policies. Indian exports, which are stronger in the last one year, have yet to gain traction. There are doubts about their competitiveness on account of shocks like demonetisation and GST, exchange rate movements, and so on. More data on exports will shed light on their behaviour before we can be certain about stronger tailwinds from this source.
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On the supply-side, agriculture’s weather dependency persists. The lack of productivity driven growth limits value addition from this sector; it is hard to incorporate much impulse from this source as result. Construction activities have yet to revive. It is difficult to imagine how soon low-cost housing initiatives can achieve sufficient scale to pull up this segment. Further, if industrial production index or IIP, the volume index, is slowing and input prices are rising faster than output prices, will high value addition in manufacturing be sustained going forward? A lot is betted upon efficiency gains from GST implantation and formalisation of economic activities, but uncertainties persist as the government keeps dithering on hard decisions on critical issues such as voucher matching for input tax credits and introducing the e-way bill system. The interactive consequence of all the forces and factors considered above is likely to restrict growth at more modest levels than before. The ground in 2018, notwithstanding a favourable external demand environment, is more challenging than that in 2014-16 when a 7-8% growth pace was sustained. It was achieved in exceptional circumstances that favoured all sectors and macroeconomic policies. The probability of replicating that performance is very low, contrary to what consensus expectations are. And we are not even talking of shrinking global liquidity and higher yields from normalising monetary policies by the advanced countries and how these may bear upon external balances and monetary policy!