Well begun is not necessarily half done

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May 25, 2016 10:10 PM

Despite external drags, growth has accelerated impressively, but the challenges are poised to rise

Narendra Modi govt’s commitment to institutionalising inflation-targeting is seen as an unwavering commitment to maintaining macroeconomic stability. (PTI)Narendra Modi govt’s commitment to institutionalising inflation-targeting is seen as an unwavering commitment to maintaining macroeconomic stability. (PTI)

As the NDA government completes two years in office, it is tempting to compare performance with promise and then come up with a prescriptive set of “to dos”. But any such evaluation is bound to be subjective. If there is a gulf between expectations and performance, who is to say where the misalignment is? Maybe, expectations were unrealistic (in either direction)? Potential, too, is in the eye of the beholder. Do we really know par-score after 8 overs in a T20 game? Maybe, the batting team is conserving wickets (read: political capital) to launch an assault later? Maybe it is being conservative because it simply believes par is much lower than commonly believed?

We therefore eschew this and take a more data-driven approach. We track the evolution of growth since the Modi government took office, try and quantify how much of this can be attributed to factors outside their control, and attribute the rest to policy. Hopefully, this will tell its own story.

In the year before the government came to power (FY14), GDP growth is estimated at 6.6% while, in the first two years of the government, growth has averaged about 7.4%. This suggests an impressive growth acceleration of 80bps. However, two caveats are in order. First, question marks remain about the new GDP methodology. None of this is suggesting mala fide intent. Absolutely not. Instead, the concern is whether, at a time of sharp relative price shocks, the deflators are being inadvertently underestimated, and growth overestimated. One potential way around this is to focus on the change in growth, not the level. Let us posit that the estimated increase in growth over the last two years (60bps in FY15 and another 40bps in FY16) reflects the change in growth on the ground even though we remain agnostic on whether the “level” of growth is really 7%+. But even this may not be an adequate corrective because the greater the oil price shock, the greater is the risk of underestimating the deflator. FY15 and FY16 is when oil collapsed, and so are subject to the largest upward growth biases. Finally, FY14 may not be the best choice of starting point because it was the year with the sharp interest rate defence that may have temporarily dampened growth. So, there are a variety of data concerns that suggest the 80bps acceleration could be an overestimate. We acknowledge these caveats but have to live with the data at hand.

But we still need to put this growth acceleration in context. Was it driven by global factors? Let’s first sum up all the factors beyond the government’s control. On the one hand, oil prices collapsed creating a large positive terms-of-trade shock that boosted growth. On the other hand, the government had to contend with two successive droughts and an export contraction, with real exports growth declining from about 8% in FY14 to an average of minus 2.6% in its first two years. So how does all this add up? Our estimate is that oil boosted growth on average by about 100bps; the droughts shaved off about 50bps, and weak export growth, driven by slowing global growth, were a very large drag, shaving off almost 150bps. All told, then, factors beyond the government’s control, did more harm than good, with the net effect being a drag of about 100bps, on average, compared to FY14. Despite that, however, the fact that growth has accelerated—notwithstanding the caveats – appears even more impressive. This outcome perhaps reflects the fact that implementation bottlenecks in the non-commodity sectors on the ground seem to be gradually abating, monetary conditions have eased, capital expenditure picked up in FY15, FDI has picked up sharply, and the disinflation has boosted household purchasing power and consumption.

So, that’s the good news on growth. The sobering news is that growth in the coming year may be headed for a slowdown because the growth drag (export weakness) is likely to stay, while some of the temporary growth boosts (oil windfall) will, by construction, roll-off. The IMF forecasts 2016 global growth at 3.2% just a shade higher than the 2015 out-turn of 3% with China continuing to slow, so the pressure on exports witnessed in 2015 is unlikely to materially abate. In contrast, the windfall from lower oil prices is a one-off and will roll off in 2016—even if oil stabilises at current levels—more than offsetting the boost from a good monsoon, by our estimates. So, we expect growth to slow in FY17, and therefore are not particularly surprised at the slew of weak data (PMI, IP, imports) over the last month. Against this backdrop, the need to keep chipping away at the remaining growth constraints (land, corporate leverage and exit, power distribution, NPAs, clearances and other implementation bottlenecks) couldn’t be greater.

But even as the growth story may be mixed, where the government and the RBI score very heavily is macroeconomic stability. From being the poster-child of emerging market (EM) vulnerability in May 2013, India is now considered the shining star of EMs in May 2016, although helped by lower oil prices.

Food inflation is a clear case in point. Despite two successive droughts, food inflation has actually moderated from 9% to 6% over the last two years! True, global food prices are down 40% in that period, but the government has been extremely restrained on MSPs—something started by UPA in 2013—and food supply management has certainly improved. This has been key to RBI being able to cut rates and ease monetary conditions. More generally, the government’s commitment to institutionalising inflation-targeting is seen as an unwavering commitment to maintaining macroeconomic stability.

In short, much good has happened over the last two years for which the new government deserves a lot of credit. But much more remains to be done. The key is not to panic if growth temporarily slows. Global potential growth has been on a secular decline since the Lehman crisis, and has pulled down India’s potential growth with it. Reversing this through important but politically-sensitive supply side reforms will take time. In the meantime we should not lose our nerve. Another member of the BRICS famously lost its nerve in 2011. And we all know how that turned out.

The author is chief India economist, JP Morgan


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