The first quarter growth performance was especially awaited for an answer to the critical question: Is there a sign of rebalancing from public to private spending in the economy? With growth in the previous two quarters firmly predicated upon the fiscal boosters, the revival of domestic demand—private consumption and fixed investment—is essential to replace the props and sustain economic recovery as the impact of the stimulus dissipates. Though the answer is in the negative from a first look at the gross domestic product (GDP) numbers, an indepth look is more reassuring.
Also See Private Demand (Graphics)
Adjusted for seasonality, private consumption expenditure growth shows a steady rebound from the sharp contraction of -1.4% in the second quarter of 2008-09. This augurs well for a shift from public to private spending, which can only strengthen in the next quarter, traditionally the busy season. This interpretation of the first quarter GDP numbers clearly suggests that the onus is now upon monetary policy to build upon this foundation and take it ahead.
At first glance, the underlying demand impulses making up the 6.1% real GDP growth in the first quarter of 2009-10 suggest no signs of rebalancing from public to private demand, even as government consumption fell sharply to 0.3% from the average 2.3% it contributed in the previous two quarters. More worrying is the fact that two-thirds of this growth is coming from net exports that have turned positive, mirroring the weakness in private demand. While fixed investment spending added 2.6%, which is historically equivalent to the 2002-03 levels for comparison, private consumption spending contributed a mere 0.9%. On a year-on-year (y-o-y) basis, private consumption growth actually slowed to 1.6% this quarter from the 2.5%-plus growth clocked in the previous two quarters. Where are the impulses of growth in the second round as the impact of the stimulus peters out, one might ask?
These are to be found in the deseasonalized private consumption data, two different cycles of which show a strong underlying trend in private domestic demand that only accelerates in the next quarter, traditionally a busy season. Seen this way, the quarterly impetus (quarter-on-quarter growth rates) shows a persistent bounce-back from the trough of September-December quarter last year; when measured at an annual rate, real private consumption grew 6.4% in the first quarter of 2009-10, up from the 5.3% in the previous one, and exceeding the corresponding 6% growth rate two years ago in 2007-08, when GDP grew by 9.2% (see graph).
Lest one think this to be a maverick trend, the y-o-y growth rates of quarterly consumption also tell the same story, though the pace is lower. In terms of historical recovery patterns following a downturn, y-o-y private consumption growth, at 2.7% in this quarter, equals that at the beginning of fiscal year 2003-04. This rebound is also supported by higher frequency indicators such as the robust growth of automobiles and consumer durables in both urban and rural markets as well as the steady increase in consumer goods’ production to 8.8% in July from 4.4% in June, which will likely be sustained in the busy months ahead.
That’s not to say the coast is clear. A firm affirmative to the question whether consumption spending has taken off would be tentative at this moment as the impact of the fiscal stimulus is indistinct so far from an independent rebound. But the strong underlying trend in the quarterly impetus does make the near-term path of macroeconomic policies a bit clearer.
To begin with, monetary policy has to nurture and advance this resurgence in private consumption for economic growth to return to a sustainable trend. The fact that private consumption was hit by the price shock of 2007-08 even before the global financial crisis struck in September drives home the point of revival in the income-sensitive component of aggregate demand. Aggregate demand in India is more sensitive to income than interest rate shocks. And the income-sensitive component of aggregate demand is significantly larger than the interest-sensitive component.
Monetary policy also has to support the countercyclical fiscal measures, the capital spending component of which will only now come into play, being subject to a longer implementation lag (for example, design, approval and implementation of new road projects). Fiscal multipliers tend to be larger if monetary conditions are accommodative, so it is crucial that interest rates do not rise due to the fiscal expansion. Apart from extracting the maximum bang for the buck as far as the fiscal stimulus goes, low borrowing costs are also essential for reviving private investment spending, which typically follows consumption with a lag.
For monetary policy to provide short-term demand support means two things: Inflation must be kept under check and interest rates low. But these two objectives appear to be in conflict at this point. The problem is complicated by the fact that most of the price increase is stemming from food inflation, which monetary policy is ill equipped to handle except in containing expectations and preventing the emergence of second-round effects. Herein lies the role for fiscal policy—to address the supply-side issues in agriculture.
The response lag in agriculture is as short as one year in many cases, so some swift, productivity-boosting reform measures might be the best way to cross this inflationary hump, prevent the premature withdrawal of monetary accommodation and extract the maximum from countercyclical macroeconomic policies.
Renu Kohli was until recently with the International Monetary Fund. Comments are welcome at email@example.com