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Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

Growth strengthens, but the battle is not over

Over-reliance on consumption for growth can become inflationary

The new estimates for economic growth for the March quarter are the latest in a clutch of data that casts light on the strengthening economic revival led by domestic consumers. The unexpectedly strong growth in output as well as indications that inflation is bottoming out leaves little room for an interest rate cut by the Reserve Bank of India (RBI) next week.

Doubts about the new method of calculating gross domestic product (GDP) continue to crop up each time the government announces new national income data. But this necessary scepticism needs to be tempered, because of less contentious micro data over the past few months—from car sales to cement dispatches to corporate profit margins to bank lending to consumers. We had commented last month that these high-frequency indicators were a positive signal.

All that said, investment demand continues to remain elusive. While the numbers are comforting, the government should not get carried away as the recovery cannot be termed sufficiently broad-based. The economy expanded at a higher-than-expected pace of 7.9% in the fourth quarter of 2015-16. With a downward revision in numbers for previous quarters, full-year growth came in at 7.6%, in line with expectations.

The reasons for weak investment demand are also well understood. On the one hand, there is still a fair amount of spare capacity in the industrial sector, and on the other hand, companies saddled with higher debt are not willing to invest at this stage. However, the hope is that rise in consumer demand might encourage private investment over time.

Apart from the consumption story, there were at least two other important takeaways from the GDP data. First, the difference between the growth in gross value added, or GVA, and GDP went up in the fourth quarter, which indicates that tax collection is rising and subsidy outflow is reducing. This should help in the management of government finances. Second, the GDP at current prices is now growing at a much faster pace than in constant prices. Nominal GDP growth came in at 10.4% in the fourth quarter, compared with 6.4% in the second quarter of the last fiscal year.

Therefore, the implicit price deflator shows that disinflation is coming to an end, which is also evident from the latest data on both wholesale and consumer price indices. Although the pickup in prices may not be an immediate threat for the economy, it should curb the enthusiasm in financial markets for rapid interest rate cuts.

So what lies ahead? The latest GDP data and the future possibilities suggest that the economy is in a reasonably comfortable position, and recovery is likely to continue because of several favourable factors. With the implementation of the recommendations of the Seventh Pay Commission for government employees, consumption demand will be expected to remain strong. Core sector data for April—also released on Tuesday—showed a significant pickup in activity. After two years of sub-par monsoon, the expectation of above-average rainfall is likely to boost output in the agriculture sector and also help revive rural demand.

Further, the micro indicators mentioned above continue to show encouraging signs and corporate earnings are also pointing towards revival. A Mint analysis of 309 of BSE 500 firms showed that in the March quarter, net sales growth was the best on record since the December 2014 quarter, while net profit growth was the highest since June 2014. Stabilization in global commodity prices will further help the corporate sector as they report numbers in nominal terms. However, it will take away the benefit of disinflation that the economy had in the last financial year which was instrumental in strengthening macroeconomic stability.

Also, as the impact of lower commodity prices tapers, over-reliance on consumption for growth can become inflationary. It will be interesting to see how the RBI is reading the latest GDP numbers as continued slack in investment and pressure from the supply side may complicate policy choices for the central bank. Increased public investment will not be sufficient.

To be sure, till now, both the RBI and the government have done well as the economic recovery has strengthened at a time when inflation has been brought under control, but the battle is not yet over. Policymakers will have to nurture this recovery so that economic growth is sustained at higher levels without stoking higher inflation. The onus, of course, will be on the government to address supply side issues in various sectors.

What should be done to achieve higher growth with lower inflation? Tell us at views@livemint.com

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