How deep is India’s economic mess?
The heads of two companies that are considered yardsticks of the broader economy have recently spoken out about the problems they are facing. Hindustan Unilever chief executive Sanjiv Mehta said in a presentation to investors that rural demand for its products has been weak because of the lingering effects of demonetization as well as the farm crisis. Larsen & Toubro group executive chairman Anil Naik said that private sector companies are not in a position to launch new projects because of the excess debt they have on their balance sheets.
Meanwhile, from within the ruling Bharatiya Janata Party, Subramanian Swamy has warned that the Indian economy could be heading for a crash, while Yashwant Sinha has written a scathing article on Union finance minister Arun Jaitley.
The narrative on the Indian economy has definitely taken on a darker hue ever since it was revealed that economic growth had unexpectedly slumped to 5.7% in the first quarter of the current fiscal year, the slowest pace of expansion in three years. The biggest analytical challenge right now—for policymakers and investors—is to separate the transient from the structural.
One part of the sharp slowdown in quarterly growth has been explained by the inventory destocking by companies before the implementation of the goods and services tax (GST) while another part has been ascribed to the technical problem of the deflators used by government statisticians to convert nominal output growth to real output growth.
Is a cyclical bounceback round the corner once the effects of these two transient factors go away? The sense we get from high-frequency data is mixed.
The manufacturing purchasing managers index (PMI) moved into expansion territory in August after the slump in July. The services PMI has been more sticky. There is some good news in high-frequency indicators such as cars, two-wheelers, tractors, air traffic and railway freight. The data for cement, coal and steel continues to be disappointing. Foreign trade offers a ray of hope. These high-frequency indicators suggest that economic growth in the second quarter could see some recovery from the disappointing levels of the first quarter.
Yet, that still leaves the question of whether India is in the midst of a broader economic slowdown. Remember that growth has been sequentially coming down for six quarters—from much before the Narendra Modi government decided to go in for demonetization in November 2016. Growth in gross value added has come down from 8.7% in the quarter ended March 2016 to 5.6% in the quarter ended June.
The new update released by the Asian Development Bank (ADB) this week offers some clues on the current state of the Indian business cycle. The multilateral lender has used statistical filters to measure cyclical fluctuations around the trend—and thus the time from the trough to peak of a business cycle. The Indian economy bottomed out in the third quarter of 2013, according to ADB. The subsequent upturn in the business cycle has lasted 14 quarters, higher than the average business cycle upturn of 12 quarters but lower than the maximum of 18 quarters.
The upshot: High-frequency data suggests that the Indian economy could see a small recovery in the second quarter of the current fiscal year while business cycle data shows that the cyclical expansion could be running out of steam.
There is also the related issue of whether potential growth—or the rate at which the Indian economy can expand without sending inflation too far away from target—has declined over the past few years. These are the technical questions that economists in the finance ministry, the Reserve Bank of India and the new economic advisory council will have to grapple with.
The Modi government has till now done well to secure macroeconomic stability as well as push through the unfinished reforms agenda that it inherited from the Manmohan Singh regime. The economic slowdown over the past six quarters as well as structural challenges like the banking crisis need the sort of clear economic thinking that this government has not believed in till now. The risk of an economic collapse seems far fetched, but an inability to deal with the ongoing slowdown could come back to bite the ruling party in the next national election.
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