Economic slowdown and revival A PIECE OF MY MIND
The growth dividends of a more competitive exchange rate policy could be sizeable, near-term and easily secured
Over the past year, the evidence has mounted of a significant slowdown in the growth of national economic output, investment and employment and raised the issue of what can policymakers — notably the government and the Reserve Bank of India (RBI) — do to revive the pace of economic activity and generate more jobs. Slowdown First, the official data on economic growth shows that there has been a steady and sizeable decline in the growth rate of gross valued added (GVA) by quarter (annualised) from 8.7 per cent in Q4 201516 to 5.6 per cent in Q4 2016-17, the latest quarter for which data is available. Most objective analysts attribute much of the deceleration in the two most recent quarters to the impact of the massive November 2016 demonetisation. They go further to point out that since the official data does not include much direct information on the unorganised/informal sector (which accounts for about a third of all non-agricultural output and over half of all non-agricultural employment) and that demonetisation inflicted disproportionately greater disruption on the largely cash-based unorganised sector, the official data probably overestimates GVA growth (post Q2 2016-17) and correspondingly, underestimates the rate of recent deceleration in GVA.
Second, the downward slide in GVA growth has also been accompanied by a significant decline in the rate of gross fixed investment (that is gross fixed investment as a per cent of gross domestic product or GDP) from 28.5 per cent in Q4 2015-16 to 25.5 per cent in Q4 2016-17. Indeed, in real (inflation-adjusted) terms, gross fixed investment in Q4 2017 was actually 2 per cent lower than a year before. Furthermore, the new Index of Industrial Production (IIP) for the first two months of 2017-18 shows a 3 per cent decline in the production of capital goods. Even more worrying for the near-term future, survey data compiled by the Centre for Monitoring the Indian Economy (CMIE) and the RBI indicates a weakening pipeline of new projects. As the RBI puts it in its August 2 Monetary Policy Statement, “The weakness in the capex cycle was also evident in the number of new investment announcements falling to a 12 year low in Q1 (2017/18), the lack of traction in implementation of stalled projects, deceleration in the output of infrastructure goods, and the ongoing deleveraging in the corporate sector.”
Third, ever since the new series of national incomes estimates was launched in 2015, there has been a significant disconnect between the GDP/GVA growth data and high frequency indicators of economic activity such as growth in bank credit, sales and earnings of listed companies, the IIP, cement production, passenger vehicle sales and purchasing managers’ indices (PMI). These suggest weaker economic activity than the official national income data. Ominously, the IIP for April-May 201718 shows just 2 per cent growth, with only 0.4 per cent expansion of the “core sector” in June. Even worse, the Nikkei-Markit composite PMI, combining manufacturing and services, fell sharply to 46 (below 50 indicates contraction) in July, the lowest level since March 2009. Of course, some of this may reflect transitional frictions of shifting to the new goods and services tax (GST).
Fourth, and most unfortunately, we lack reliable and up-to-date information on national employment levels and trends. The last large sample National Sample Survey was for 2011-12. Until the next one comes out, perhaps the best guide to what is happening to employment is provided by the CMIE’s “Waves” of Consumer Pyramids Household Surveys, which cover over half a million adults and began to include employment/unemployment data in early 2016. These show that total employment (including in the unorganised sector) in JanuaryApril 2017 had fallen by 1.5 million compared to the September-December 2016 Wave, with job-losses concentrated in the younger age brackets. Furthermore, these surveys point to significant declines in the labour participation rates (see Mahesh Vyas’ article in this paper of July 11, 2017). Such worrying declines are consistent with the production slowdown narrative and the expected impact of demonetisation.
Based on current trends and policies, and bearing in mind the inevitable transitional disruptions of the major new GST reform, it is unlikely that GVA growth in 2017-18 will exceed 6 per cent. Nor is total employment likely to increase significantly, given the special stresses of GST transition for the unorganised sector and the consequences of recently tightened regulations for slaughter and marketing of bovine livestock and the associated “cow vigilantism”. Revival? So what can be done to revive the flagging economy? In the medium term, ongoing structural reforms (such as GST, the new bankruptcy code and the government/RBI efforts to reduce the massive twin balance sheet problems of banks and highly indebted companies) as well as possible new ones relating to education and skills, labour laws and land markets could spur growth. But their growth dividends are unlikely to be significant in the next 12-18 months. For the near term, we have to turn to macroeconomic policies.
Fiscal policy offers little scope. Even if the Centre’s budget targets are met, the demonstrated fiscal laxity of states (loan waivers, etc) will likely ensure that the combined fiscal deficit in 2017-18 is close to 7 per cent of GDP. That leaves no room for any further pump-priming, other than the “frontloading” of budgeted expenditures, which the Centre is already doing to an unprecedented degree. Indeed, with the huge uncertainties relating to short-term GST revenue yields and usual shortfalls on disinvestment receipts, the Centre’s fiscal deficit targets may be breached.
Monetary policy could (and should) have cut policy rates earlier and more aggressively given the sharp declines in the rate of consumer price inflation in recent months. But given the various supply rigidities in the economy and the pervasive overhang of the twin balance sheet problem, it is doubtful that an additional half a per cent or so repo rate reduction will trigger significantly higher investment and growth.
Exchange rate policy is the domain where government/ RBI policy has erred seriously in allowing substantial over-valuation of the rupee over the past 18 months and continues to do so (see my article, Business Standard, 11 May, 2017). This has discouraged growth of both exports of goods and services and domestic production of import substitutes. The growth dividends of a more competitive exchange rate policy could be sizeable, near-term and easily secured, and the sooner we reap them the better for growth of GVA and employment.