- The recently released data for the first quarter of 2017-18, showing GVA (gross value added) growth at only 5.6%, should be seen as a warning signal.
What is most disturbing about this slow growth?
- It is the industrial growth (which includes construction) was only 1.9% over the same quarter in the previous year, the lowest in 21 quarters.
- As industrial growth is the only sector that will generate much of the employment needed outside agriculture.
- Thus, policy makers would be well-advised to worry and take corrective steps.
What is the problem?
- The slowdown in the last two quarters has focused on whether it was due to the impact of demonetization or, more recently, the destocking effect of the goods and services tax (GST)
- Demonetization impact also lasted longer, but the economy will recover from this one-time shock.
- The destocking effect of GST is almost certainly a one-quarter problem.
- The real problem is that these short-term phenomena are masking a more worrying underlying downward trend in growth.
- GVA growth had increased from 7.2% in 2014-15 to 7.9% in 2015-16.
- It then slowed down to 6.6% in 2016-17, and the first-quarter results for the current year suggest that the deceleration is likely to continue.
Weak Investment demand
- Gross fixed capital formation in current prices fell from 31.3% of gross domestic product (GDP) in 2013-14 to 27.1% in 2016-17. This needs to be reversed.
- While public investment increased from 7.1% of GDP in 2013-14 to 7.5% in 2015-16, this was more than offset by a decline in private capital formation.
- Private (corporate) capital formation declined marginally from 13.1% of GDP to 12.9%.
- The household sector saw a much sharper decline from 12.6% to 10.8%.
- This is especially worrisome because the household sector includes small non-corporate businesses and is a major creator of employment.
- In fact, when the data for 2016-17 become available, they may show a further decline in this sector because it was the sector most adversely affected by demonetization.
- Private corporate sector investment is constrained by balance sheet stress.
What will have the maximum impact?
- Improving infrastructure, especially roads, power and railways, is undoubtedly the best way of “crowding in” private investment.
- Setting clear targets and monitoring progress in public investment in infrastructure will help.
- Small businesses need an urban environment that gives them economies of agglomeration, ease of doing business and low transaction costs.
- A clear timeline by which the Centre plans to meet specific goals linked to creating an investor-friendly environment, and monitoring progress, would send a positive signal to business, and also encourage individual states to do their bit.
- Fixing the slowdown in bank lending is low-hanging fruit.
- There are many structural items on the agenda, such as mergers of banks, recoveries of non-performing assets through the bankruptcy code route, and recapitalization of public sector banks.
Weak Export Performance
- Exports are often mentioned as providing a demand-side stimulus for GDP, but this understates their importance in promoting growth.
- While exports add to demand, the imports which they finance constitute a corresponding leakage from demand.
- The real case for a greater export effort is that it will increase India’s linkage with global markets and global technology trends, with potential productivity gains.
- It will encourage the growth of strong Indian firms exporting to world markets, and planning their scale of production to achieve and maintain global competitiveness. This will also make them generators of high quality employment in the process.
What is required to be done?
- A credible export agenda requires policy interventions that lie outside the domain of the commerce ministry.
- These include improvements in infrastructure and logistics, building coastal employment zones, better bank finance for exporters, and most important, labour law reform.
- Progress in these areas requires a clearly defined agenda, with full inter-ministerial commitment on implementation.
- On issues such as labour reform, a strong political effort is necessary to convince all stakeholders of the need for these reforms.
- We also need a political decision on the endless Regional Comprehensive Economic Partnership (RCEP) negotiations.
Exchange rate policy and interest rates
Exchange rate policy
- The real effective exchange rate has appreciated by about 9% over the past few years against our trading partners.
- This has an adverse impact on exports and also on domestic producers competing against imports.
- A strengthening exchange rate in an environment where exports are weak, and domestic producers are asking for tariff protection, is a sure sign of exchange rate misalignment driven by strong capital flows.
- The Reserve Bank of India (RBI) should be persuaded to target the real effective exchange rate more effectively.
Interest rate policy
- Interest rate policy is another instrument that can have a short-term impact.
- The RBI’s repo rate is not by any means the only factor that is relevant in reviving growth.
- However, when inflation is well within the tolerable range, and growth in the first quarter has dropped to 5.6%, compared with the RBI target of 7.3% growth for the year as a whole, there is surely a case for more aggressive lowering of the interest rate.