Weaker GDP growth in Q3 could abort fiscal consolidation plan

External demand continues to be sluggish and within domestic demand, it’s likely to be consumption that will drive growth


The GDP numbers are being published barely three weeks before the central budget and any weakness in growth could tempt the government to abandon its road map for fiscal consolidation. Photo: PTI
The GDP numbers are being published barely three weeks before the central budget and any weakness in growth could tempt the government to abandon its road map for fiscal consolidation. Photo: PTI

The gross domestic product (GDP) numbers for the December quarter will be out on Monday. Growth in gross value added (GVA) was 6.1% in the March quarter, 7.1% in April-June and 7.4% in the September quarter. Will the recovery continue to build up steam?

More importantly, what if it doesn’t? The GDP numbers are being published barely three weeks before the central budget and any weakness in growth could tempt the government to abandon its road map for fiscal consolidation. The finance ministry’s mid-year review of the economy has clearly spelt out the policy implications. Here’s what it said: “Data uncertainty and the mixed signals sent by the economy suggest that more attention should be paid to the demand side of the economy. The sharp and continuing decline in nominal GDP growth, as well as the fact that the economy is powered only by private consumption and public investment—is a cause for concern... It is, in this context, that the government’s commitment to further fiscal consolidation of 0.4% of GDP needs to be re-assessed.” That’s fairly explicit—it suggests that, if growth is slowing, the government feels it’s time to jettison the 3.5% fiscal deficit target for 2016-17.

So, what is growth expected to be in the December quarter? The Reserve Bank of India’s (RBI’s) Survey of Professional Forecasters on Macroeconomic Indicators, published last Friday, is the document to consult on this score. The survey was conducted in January, so it has the most up-to-date predictions. It says the median forecast for GVA growth for the third quarter of 2015-16 is 7.3%, a notch below the growth rate in the previous quarter. The range is from 6.8% all the way up to 7.7%, but the median is 7.3%.

But is the RBI survey just another of those soothsayers’ prognostications, to be taken with the usual spades of salt? Well, the surprising thing about this forecast is its rather decent recent track record. In the previous survey, which RBI carried out just before it released the September quarter GDP numbers, the median forecast for the quarter’s GVA growth was 7.4%, which was bang on target.

That’s not all. Before that, in a survey carried out last July, the median forecast for the June quarter GVA growth was 7.2%. It actually came in at 7.1%.

Of course, the survey did get the March 2015 quarter GVA growth horribly wrong. And it’s true that the median forecasts for the individual sectors—agriculture, industry and services—were way off target. Nevertheless, the fact remains that, for the last two quarters, the RBI survey of professional forecasters has done a good job of forecasting headline GVA growth.

The forecasters seem to be ignoring the base effect, which is sizeable. GVA growth in the previous year, in 2014-15, was 8.4% in Q2 and 6.8% in Q3. Which suggests, everything else remaining the same, growth in Q3 2015-16 would be higher as it would have the advantage of a substantially lower base. But growth at constant prices was boosted in the September quarter because of a negative GDP deflator, the result of massive deflation in the Wholesale Price Index (WPI). Nominal GVA growth was 5.2%, far below the growth rate at constant prices. In the December quarter, WPI, although negative, has gone up a bit and the GDP deflator, too, is expected to be higher.

The accompanying chart has the median growth forecasts for the various sectors for Q3, together with the actual growth numbers for Q2 and Q1. It shows that while growth in agriculture and allied activities is likely to be the same as in Q2, industrial growth will probably take a hit, while growth in services is predicted to be much stronger.

How well does this fit in with RBI’s own assessment? RBI’s latest monetary policy statement says, “On the domestic front, economic activity lost momentum in Q3 of 2015-16, pulled down by slackening agricultural and industrial growth.” So, the central bank agrees with the survey that growth will be lower in Q3 and that industrial growth is weak. But, unlike the survey, it believes that agricultural growth, too, will be lower, what with the monsoon ending with a 23% rainfall deficiency relative to the long-period average. About industry, RBI said growth in capital formation had decelerated and industrial activity was weak. The floods in Chennai in December also affected output, seen from the contraction in the manufacturing Purchasing Managers’ Index in that month. In services, RBI says the indicators are mixed, with construction and railway freight growth weak, although the services PMI rose to a 10-month high in December.

What will be the sources of demand? External demand continues to be sluggish and within domestic demand, it’s likely to be consumption that will drive growth. The professional forecasters’ survey pegs the median growth rate of private final consumption expenditure at 8%. That’s higher than Q2’s 6.8% growth, or even Q1’s 7.4%. And for those who continue to be sceptical of the new GDP series and want to know how bad things really are, Bank of America Merrill Lynch says, in a report dated 28 January, that it expects 5% GDP growth as per the old series, marginally below 5.2% growth in the September quarter.

Manas Chakravarty looks at trends and issues in the financial markets. Comments are welcome at capitalaccount@livemint.com

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