A wake-up call for Mumbai and Delhi
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Let us cut to the chase. With India releasing its provisional estimates of the annual national income for 2016-17 and quarterly estimates of the gross domestic product (GDP) for the fourth quarter of 2016-17, it is time for some plain-speaking. This economy does not deserve the tag of the world’s fastest growing large economy. It is actually in crisis. The emperor is almost naked, if not naked already.
Government spending and the surging iron ore production in 2016-17 have saved many a blush. Without them, GDP growth for the full year would have been far more anaemic. Government final consumption expenditure rose more than 25% in nominal terms and by more than 20% in real terms in 2016-17. Iron ore production rose to an estimated 200 million metric tonnes in 2016-17. That is why the ‘mining and quarrying’ sector gross value added (GVA) surged by 33% (year-on-year) in the fourth quarter of 2016-17.
Sajjid Chinoy of JP Morgan, in his lucid analysis of the data, repeats that the economic slowdown had been in the works since 2016. He does not spend much time reflecting on its causes. We can do some loud thinking here. It must be because private capital formation has been in the doldrums. At current prices, the ratio of gross capital formation to GDP had sunk to a new low of 25.5% in the fourth quarter of 2016-17. That is a shocker and an important reason for the call to action that this column makes.
The question of whether the government’s ‘note-ban’ exercise added to Indian macroeconomic woes has now been answered. It has. Worse, it is not done yet. Just a casual glance at the GVA of finance, real estate and professional services would tell us that it will take quite a few quarters for it to reach the level last seen in the second quarter of 2016-17. If financial and real estate services are recovering only slowly from their slump in the third quarter of 2016-17, we should expect the construction sector to continue to show contraction in the quarters ahead. It was inexplicably positive in the fiscal third quarter, only to decline in the fourth quarter.
India’s GVA and GDP deflators had risen in tandem with the wholesale price index (WPI) in 2016-17 compared to 2015-16, after the recent data revisions. According to Chinoy, WPI inflation accelerated from -2.3% in 1Q16 to +5% in 1Q17—a swing of 7.3 percentage points. That explains the slump in growth in real GVA from 7.9% in 2015-16 to 6.6% in 2016-17 even as nominal GVA growth rose from 8.5% to 9.7%. But let us remind ourselves that the acceleration in nominal GVA growth owes itself to one item: iron ore production. Mining and quarrying went from -5.7% in 2015-16 to +1.9% in 2016-17.
Further, if we were willing to accept higher real GVA growth in the past two to three years without questioning the suspiciously low deflator growth, we cannot reject the real GVA growth number now just because the deflator growth has risen sharply. No point in breaking the mirror or the thermometer. The truth is that the national income data (low frequency) are now aligned with high-frequency indicators such as growth in cement production, industrial production and bank credit. They had been flashing warning signs for quite some time.
The monetary policy committee (MPC) of the Reserve Bank of India (RBI) must be feeling at least a trifle embarrassed. The MPC moved to a hawkish stance in February. Data revisions have shown that to be a hasty move. Of course, we are commenting with the benefit of hindsight. What matters is what they do on 7 June. It’s a test of their intellectual openness. They must change their stance when the data changes. Some analysts have come around to the view that food inflation deceleration is more structural than cyclical. No doubt, goods and services tax (GST) implementation is a risk factor. However, with the government threatening draconian actions and punishments (not that it worked in Malaysia), price increases on the back of GST implementation could be muted. Ultimately, all monetary policy decisions are judgemental.
I have argued against the efficacy of interest rate cuts in reviving capital expenditure in the real economy in a balance-sheet constrained environment. That said, India’s real rate is not negative, as it has been in advanced nations in the last eight years. Ultra-low or negative rates do not help revive investment spending. India’s real rate of interest—based on realized consumer price index growth—is quite positive and there is room for some reduction. On balance, after the release of the GDP data, the risk of being wrong with a rate cut appears lower than the risk of being wrong with an unchanged stance. The MPC should vote for a 50-basis point rate cut immediately with an unchanged neutral stance .
If, unfortunately, the rate cut leads to a surge in stock prices, the government must take advantage of it and push through several stake sale plans. Further, the government must introspect. With the budget for 2017-18, it missed an important opportunity to revive animal spirits, especially in the aftermath of the ‘note ban’ exercise. Perhaps fresh thinking is needed in certain ministries.
Further, the government must step out of the hologram and accept the reality of an unhealthy economy. If the capital formation rate of 25.5% number does not wake up the RBI and the government, nothing else will.
V. Anantha Nageswaran is senior adjunct fellow (geoeconomics studies) at Gateway House: Indian Council on Global Relations, Mumbai. These are his personal views.
Read Anantha’s Mint columns at www.livemint.com/baretalk.Comments are welcome at firstname.lastname@example.org