The surprising 7.9% gross domestic product (GDP) growth in the September quarter has impressed markets and observers, but beneath the buff, private demand drivers are yet to take off by themselves. The strong rebound in private consumption is largely a function of the various government stimuli, while the second wave response—private investment stepping in as government spending bows out—has not yet gotten a firm grip. Stripped of the handsome 2.2% contribution of government spending, and its effects upon private demand, real GDP still does not seem to have turned decisively.
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Private consumption contributed 3.1 percentage points of the 6.7% growth on the demand side. That’s good, for that was the policy intent. The rebound in consumption is also genuine, as evidenced by a steady upward sequential trend from April-June 2008.
But the spike of a 5.5% year-on-year (y-o-y) consumption growth belies a considerably weaker trend, confirming that consumption advanced due to the fiscal stimuli. To compare, the three-quarter moving average of the series (when taken on a deseasonalized quarterly basis) bolted up to 3.6% against a trend average of 0.4% from the first quarter of 2008-09. We can reasonably expect this one-off spurt in consumer spending to sober down closer to the trend over the next six months (though maybe not so much in the next quarter as some of the festive spending spills over). It is not insignificant that y-o-y sales of the top 2,000 companies dropped 6% in the same quarter.
This weakness is also reflected in the investment response. On the surface, the 7.3% y-o-y growth in gross fixed capital formation is impressive, contributing as much as 2.5 percentage points to GDP growth. But total investment added only 0.7 point, as inventory depletion subtracted 1.4 points, almost entirely explained by the big step-up in consumer demand.
The inventory cycle is still unpredictable in the Indian business cycle, but both total investment and gross fixed assets (the gap between the two roughly equals inventories) have usually moved in tandem in this decade; except at the start of 2001-02, after the dot-com bust. Comparing investment behaviour then and now shows a similar divergence. Inventory restocking in 2001-02 did not begin until about two-three quarters after net fixed assets accumulated by businesses rose. Total investment spending remained subdued as a result and lagged sustained private consumption by more than two quarters. Both 2001-02 and this current year are unusual (since they come after busts), and if past trends are a predictor, the resumption of sustained investment spending—including inventory rebuilding—should take a couple of quarters at least. Bank lending, which finances working capital requirements and is at cyclical lows—mimicking 2001-02 trends—is consistent with these movements, notwithstanding the increased reliance upon cheaper, non-bank funds.
Other investment indicators are also tentative. The demand decomposition of the last quarter shows that the 6% addition from net exports—which always turns positive in India when growth falters—is straight off a sharp 29.8% contraction in imports growth, double the contraction seen in exports. A sure sign of tough financing conditions abroad, this indicates that stalled and new projects did not resume in the last quarter at least; despite the decline in overseas interest rates, spreads plus hedging costs still make external financing dearer relative to domestic borrowing. Trends in capital goods growth show it at 2003 levels, though it has resumed positively from June 2009. And corporate profitability so far is largely attributable to cost-cutting and productivity increases, with sales not really propping the revenues; further down the road, firms have little elbow room below as input prices— for example, commodities—rise.
It’s thus too early to judge whether the downward slide in investment from 2007-08 has been arrested. The demand for capital goods is strongly influenced by profitability, the rate of change of output, interest rates and taxes—plus a time lag—and not all of these determinants are in place right now. There’s also little likelihood that private corporate investment will recover so quickly to earlier peaks. The doubling of GDP during the 2003-07 boom was investment-led, when private corporate investment grew an average 24% annually. Inevitably, a phase of consolidation and rationalization has to follow, as is indeed visible in private corporate activity; for example, deleveraging to work out the excesses of the boom years, balance sheet restructuring, bargain-buying of stressed firms within India and abroad to consolidate, and so on.
This does not mean an “all-fall-down” scenario for private demand ahead; rather, it’s just that the drivers are not holding hands in a virtuous grip across all segments at this point. These will dodder in the near term as the stimulus wanes, input prices rise and inflation gains. Therefore, the current growth rate cannot be sustained unless these pick up speed, which will take a while.
Meanwhile, the underlying trends in demand only emphasize the need for government-sponsored infrastructure projects to provide impetus to private investments and support consumption too, the construction sector being a mass employment sector.
The next quarter’s GDP performance will be a critical pointer to how much of this recovery will sustain, and to how less generous policies can be hereafter. But these will not be available before the Reserve Bank of India (RBI) reviews its monetary stance. Undoubtedly, the focus is now upon inflation, but RBI’s words and deeds also indicate a gentle and gradual withdrawal of monetary accommodation.
Though RBI would be disinclined to move straight to interest rate tightening in the light of many contradictory indications—divergent trends in food and core inflation, unutilized capacities in many sectors and poor credit offtake, to name a few—admittedly, it might be a tough call. One tug at its conscience would be that the extraordinary 7.9% growth all but closes the output gap—the difference between potential and actual GDP—on the surface. It’s the underlying trends that it may reckon with.
Graphics by Ahmed Raza Khan / Mint
Renu Kohli was, until recently, with the International Monetary Fund. Comments are welcome at email@example.com