On the morning of Monetary Policy Committee release of the outcome of its review, it might be a good idea to take stock of the current growth environment. Much has been written about the need for a policy stimulus, particularly a large fiscal push, but there isn’t a lot of analysis of the nature and causes of the slowdown, the absence of which largely renders the solutions out of context and mostly irrelevant. The following takes somewhat of a counter-view on this narrative of a sharp slowdown in the recent quarters, and shows that the process is indeed somewhat “technical” in nature, the result of the movements of what statisticians and national accounts experts call “deflators”. To cut a long story short, our hypothesis suggests that the slowdown has been a feature of growth for a much longer period—the past three years—and that it was the GDP deflator which distorted the lens through which we were viewing growth. We consider non-agricultural Gross Value Added GVA (NA-GVA) in this analysis (a combination of industry and services sectors), since the agriculture segment has different dynamics.
The accompanying graphic shows co-movements of nominal (current prices) and real (constant prices) NA-GVA (quarterly series) since June 2012 (i.e., FY13). The two series move in a stable, predictable pattern before June 2014. Post this quarter, the patterns of movement are seemingly uncorrelated, and very different. The notable feature is that while nominal growth dropped sharply (from an average 13.5% over June 2012-September 2014 to average 9.3% over December 2014 to June 2017), real GVA rose from an average 6.8% to 8.1% in the corresponding period. We believe that a large part of the differences is explained by the move of the deflator, which was determined by the sharp drop in oil and commodities prices since mid-2014.
The accompanying graphic also shows the movement in the GVA deflator (which converts nominal to real GVA). [Nominal GVA growth – Deflator (%)= Real GVA growth]. About 41% of nominal NA-GVA is deflated by the WPI, another 30% by the CPI and the remaining 30% of real GVA is estimated using volume indicators. While CPI inflation has remained broadly stable over the past five years, there have been large variations in the WPI. Consequently, given the weights, the general and NA deflators have more closely followed the deflators over the years. The broad point is that from peaks of over 6% in June 2014, the NA deflator sank to -2% in March 2015, before moving up gradually back to 6% in March 2017.
But there is certainly a compelling story. Nominal NA-GVA growth is largely estimated from published corporate quarterly reports, with revenue growth being the core estimation indicator. The essence is that while nominal growth sharply since June 2014, real GVA growth first picked up as the deflator fell, then remained stable while the deflator bumped along at a low level till June 2016 and then began to decelerate as inflation picked in mud-2016.
But the question then, again, is how much did a volume slowdown contribute? Over the period June 2014 to September 2016, there is a disconnect between real manufacturing growth and the Index of Industrial Production (both show real growth). This suggests that the GVA-M deflator played a role in boosting GVA-M growth. However, the sharp, unusual divergence of manufacturing corporate revenue growth since June 2016 from the volume indicators suggest the growing effects of cascading supply shocks (the Benami Act, demonetisation, preparations for GST, Real Estate Regulation Act, etc.).
The implications for policy is as follows. Some of the recent sharp slowdown might be countered by focusing on facilitating resumption of working capital (speedy and rational credit refunds for exporters, unclogging the filing system, easing some of the filing requirements, etc).
Deeper thought is needed for countering the long persisting “demand” slowdown. A fiscal stimulus is not new money; it is transferring resources from one set of (private sector) entities to another (the public sector) with the hope that “marginal propensities to spend of the two entities are different, and that of the latter, superior. There is little empirical evidence of this. In itself, with the lower expected FY18 GVA growth, the budgeted borrowing will increase the fiscal deficit (as a percentage of GDP).
Much to its credit, the Centre seems to have recognised this narrative in its response, with the finance minister stressing the need for balancing the required stimulus with fiscal prudence, reportedly establishing a Rs 30,000 crore fund to facilitate export credit refunds, and other supply easing measures. Longer term structural reforms, including mitigating the twin balance-sheet problem, will be the appropriate response.
As a coda, empirical evidence strongly suggests that countries which have initiated far-reaching structural and governance reforms will inevitably have large transition costs which will have a braking impact on economic activity. Economists and analysts have, for a while, pointed to the transient adverse impact of the introduction of GST and VAT structures in a range of economies, both developed and emerging. Perhaps we were not emphatic enough. India’s reforms are both broader and deeper in scope, with more transparent bidding systems, better risk allocation in partnership projects, measures to improve tax compliance, punitive actions against wilful default, and so on.
The incentive of earning super-normal profits has significantly diminished, which have further weakened new capex. The slowdown is an inevitable adjunct, even as a superior structural ecosystem is developing. The government and analysts, together, need to better articulate and disseminate this.
With contributions from Abhaysingh Chavan
Senior vice-president, business and economic research, Axis Bank , Views are personal.