The economy has moved from difficult times into uncertain times. During such periods, companies tend to live by the quarter. On the other hand, economies are—and ought to be—much more long-term. It may be a sign of the corporatization of the Indian economy that even policymakers now seek to think by the quarter.
Every time a good quarterly gross domestic product (GDP) number comes in, recovery is announced; every time a subdued Index of Industrial Production (IIP) number is released, doubts of double dip surface. Equity and money markets, of course, react to all this information instantly, but should macroeconomists and policymakers be so swayed by one or two quarterly numbers? Not so long ago, there were no quarterly GDP numbers.
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The economy, it seems, has grown at 8.8% in the first quarter of this fiscal. At a time when there are inflections in overall growth, the source and structure of growth, more than the rate, become important for determining its sustainability. Identifying the sources is important, as these are imperative for formulating economic, especially monetary, policy.
The source of this growth is contentious; while it is clear where it is emanating from, it is difficult to reconcile it with growth in tangible assets, as well as with its economic and functional moorings.
Analysed thus, it is certain that this growth is not driven by domestic demand. Private consumption demand has stagnated, rising only 0.3% over the corresponding period last year, and government consumption is lower than last year. Credit offtake also corroborates this view. The growth of bank credit, excluding that to telecom and oil companies, is struggling to get into double digits. On an incremental basis, a large chunk of credit is accounted for by sensitive sectors, especially real estate.
More importantly, despite a substantial increase in financial investments in the economy, there is little evidence of heightened and sustained capital expenditure.
It’s no wonder that companies are seeking to raise money through bonds and not tenured loans. The former has no end-utilization issues, whereas the latter is disbursed for specific projects based on the achievement of physical milestones. Even within tenured loans, the incidence of corporate loans, compared with project-specific ones, is at its highest in recent times. Individual banks may show high loan growth, but that has more to do with debt restructuring than with creating new capacities.
This shift makes banks vulnerable to sharp drops in earnings, as it exposes them to risks of mark-to-market losses in a rising interest regime. It also has serious implications for the sustainability of growth.
The macroeconomic problem emerging from this trend is that liquidity is no longer getting deployed in the fundamental way that has been the hallmark of the Indian economy. It was the asset-based deployment of liquidity that helped India weather the global meltdown.
The fact that end use of debt raised by companies is not being monitored by lenders because of the form in which the debt is contracted, means there is a real possibility of an asset price bubble surfacing again.
In macroeconomic terms, the analytics of the current situation is that on an economy-wide basis, capital is being kept intact without any increase in capacity. This could also mean that at a micro level, there is some replacement and maintenance expenditure being incurred, but fresh capacities are certainly not being created.
This trend is reflected in another sphere as well: The amount of currency in the hands of the public is at its highest level in the recent decade or so.
While this amount reflects the anticipation of a heightened transactional velocity, the surge in its growth needs to be read differently.
It is not yet entirely clear if this increase is being caused by sustained inflation, or because of increased output from high cash consuming and generating sectors, such as construction. Another reason, with limited macroeconomic implications, could be the increased level of social security payments under the government-sponsored schemes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme.
On the external economy front, a current account deficit of around $40 billion is adding complications to sustainability as well as management of the recovery.
Given the global situation, foreign inflows are bound to be less predictable. But the real point is that managing this level of deficit is going to be a challenge. Heightened inflows will only make monetary management, and by extension the management of the recovery, complicated.
If indeed this is the overall scenario, aggressive monetary tightening—which has all but been decided—is more likely to impair growth than influence inflation.
Haseeb A. Drabu is former chairman and chief executive of Jammu and Kashmir Bank. He writes on monetary and macroeconomic matters from the perspective of policy and practice. Comment at firstname.lastname@example.org