Rate Cut Panacea : A policy rate cut by the RBI can spur consumer demand and industrial output, boost employment and scale up economic growth.
A policy rate cut by the RBI can spur consumer demand and industrial output, boost employment and scale up economic growth.
The Indian media has been abuzz with the RBI's Monetary Policy Committee (MPC) discussion on a proposed reduction in interest rates for the Indian economy. With inflation coming down and signals from other economic variables open to interpretation, there are a plenty of arguments as well as counter- arguments as to whether this is the right time for an interest rate cut.
In the backdrop of this discussion, let us examine the nation's inflation as well as other economic data and try to make some sense of them. It is also important to note that markets, both equity and forex, have been showing enthusiasm towards the Indian economy.
For all its intents and purposes however, a policy rate cut may be an appropriate action for completely different reasons. The Indian economy, arguably, is not necessarily in good shape. Policy initiatives to increase consumer demand are important in order to sustain the economy's growth and provide employment.
It is obvious that inflation is slowing down right now, primarily due to a reduction in food prices. A crash in the prices of pulses and some vegetables has contributed significantly to this drop. But is that a sustainable trend?
Although the core inflation (inflation sans food and fuel) is holding steady, and it's still above the nation's inflation target, the low level of food inflation could be indicative of higher inflation in the future. One needs to examine whether the country's inflation is falling due to increased supply of food and food products alone, or whether there is a constraint from the demand side as well.
A reduction in interest rates has significant implications for industrial growth and employment generation in the Indian economy. If the RBI's MPC meeting minutes are anything to go by, there's a discernible gap in output, with current capacity utilisation pegged at around 70 per cent. It is quite obvious that capacity utilisation isn't exhibiting healthy trends of late. The growing output gap doesn't augur well for employ- ment or economic growth.
It's evident that the effective pending orders, including new orders, are declining and have been in the negative for the past four quarters. This is a clear indicator that growth in the economy is lagging. An examination of the average inventory of finished goods and raw materials throws up an alarming trend as well.
The quantity of finished goods as a percentage of sales is going up, while the raw materials to sales ratio is coming down. These indicators all point to the fact that manufacturers are worried about the future. If they were expecting growth in sales, they would likely have stocked more inventories of raw materials despite the mounting stocks of finished goods. Obviously, producers are opting for a wait-and-watch strategy on the production front.
Data and trends on the country's overall industrial production growth also seem ominous as demand in the economy continues to be subdued. There needs to be enough corrective actions taken to propel consumer demand in order for the economy to grow and generate employment.
It's evident that although core inflation is currently holding steady, the growing demand gap is a major issue. If demand doesn't increase, there could be mounting pricing pressures that will have a serious impact on the manufacturing sector as well as the health of India's overall economy.
Unreliable jobs data
India's unemployment levels are a curious dynamic. For over two decades, India's official unemployment rate has been the lowest among the world's major economies. You may wonder how one of the world's most populous countries, possibly even the world's largest population below the poverty line, could boast of such a
feat. You wouldn't be the only crit. According to the World Bank, a third of India's population lives with less than $1.90 a day.
Meanwhile, the Indian government itself often contradicts the nation's unemployment data. According to the nation's 2011 Census data, unemployment was more than 15 per cent among educated people. How then did the country manage to consistently maintain an unemployment rate of less than 3.5 per cent among the world's major economies? The discrepancy here arises from several employment guarantee schemes that are run by the Indian government. The number of days worked or the total amount of money earned notwithstanding, if a citizen at any point had been employed by the scheme, he or she is stricken from the unemployed list. This would easily explain the lower rural unemployment rate despite the better part of the population falling below the national poverty line. It also explains the higher unemployment rate among educated and urban citizens. Further, the actual number of days worked and total earnings from these schemes could be far lower than the official data, given the pilferage in all such government schemes.
Figures about actual unemployment rates or the level of under-employment aren't easily available. Most developed countries provide unemployment allowance and hence generate valid data based on the number of people who avail themselves of it. Eligible citizens need to periodically prove that they tried to secure employment but didn't succeed in order to qualify for continued assistance. India neither maintains a database of eligible unemployed people nor provides any allowances. That, obviously, makes it easier for different agencies to "derive" numbers that suit them best. Given the subjective nature of such data, can they really be useful while planning out serious policy or investment plans?
One of the fastest growing large economies in the world over the past few quarters, India has an interesting growth story. The Indian economy has definitely grown much faster after 1991. Is India's recent growth really that high however, and if so, is it sustainable? We need to adjust the data on at least two counts in order to get a comparable story.
First, we need to factor in a significant reduction in oil prices over the past year; it's had a sizable impact on the Indian economy, a major importer of oil. The Economist expects the low prices to contribute about 2 per cent to India's GDP growth. If that is true, then the current growth isn't as sizable as one could make it out to be.
Next, we need to account for the fact that India has been shifting a greater portion of its unorganised economy to an organised space. The current period's GDP numbers would then, of course, be skewed. The size of this shift adds directly to the measurable economic growth.
There is, however, no direct and easy means to reliably quantify the size of that addition. Take, for example, India's recent tryst with demonetisation. The government claims that the move would be a significant step towards drawing assets from India's informal economy to conventional channels. If that's true, we should see significant growth in several sectors over the next year due to the infusion of these erstwhile unaccounted for assets. Further, the estimated growth could be higher after adjusting for the minor negative impact of demonetisation during the previous financial year. The best forecast of GDP growth for the next year falls short of these expectations however, pegged at just about 7.5 per cent.
It's also worth noting that this estimate is on top of the positive effect that changes in how India's GDP (estimation of GVA vs the earlier method of GDP calculation) is now measured. The revised method had boosted India's 2013-14 GDP growth forecast to 6.9 per cent, up from the 4.7 per cent forecast estimated earlier using the old methodology. Though the current methodology is definitely an improvement and comparable to global standards, the numbers over the same period cannot be compared without adjusting the previous (or current) numbers in order to get a balanced comparison.
Reality of growth
There has been a lot of discussion on the growing number of unemployed individuals in the Indian economy. Obviously, people do not believe the official figures for India's unemployment rate. They do, however, believe the growth numbers are real. Both these numbers appear to be unreliable, and hence, we need to accept the fact that the Indian economy is not growing steadily enough to generate employment levels that can satisfy the million new entrants that seem to be entering India's job market every month.
It is also important to examine the other major signals that the numbers are giving out. Even if the number of layoffs in India's IT sector is smaller than what the media has made them out to be, the fact remains that existing players in India's seasoned technology sector are reducing their workforce. New jobs created by the nation's start-up ecosystem as well as other new businesses are not able to offset these losses. This may have a long- term impact on the country's employment market and overall economic growth.
Other segments of the economy aren't faring too well either. After quite a few years of scanty rains, India was expecting a normal monsoon this year. The monsoon has been uneven however, with different parts of the country experiencing either floods or droughts. This uneven spread is likely to significantly impact India's sizable agricultural and rural economies.
Though the GST rollout would have a very positive impact on the economy in the long run, the shortterm impact may not be positive. The rushed in manner (though there was enough time) and the over-complicated structure could make the implementation messy.
The Indian banking system's NPA resolution movement could have an additional impact on the economy as well, possibly boosting employment growth. If the RBI and other banks take this really seriously, it would effectively bring asset sales at significant haircuts, bankruptcy proceedings against some companies as well as higher provision and greater demand for capital from banks and other institutions. This would collectively reduce some amount of employment and economic value in the near future while making the banking system healthier in the long run and boosting long-term economic growth.
Another significant factor looming over India's economic future is the impact of the country's farmers' loan waivers. Without going into the merits or demerits of the waivers, it is easy to conclude that its impact would be net negative for the economy as resource- starved State governments would have to absorb this cost, and this could stall infrastructure developmental projects.
Time to act
The demand side of the economy seems to be constrained, with many worries coming to the fore. In addition, many other economic and other signals points to negative implications for economic growth and employment generation.
India needs to boost consumer demand in order to tide over these problems, enabling the economy to grow and generate employment. A policy rate cut would, therefore, be a reasonable action to take.
Additionally, one needs to examine the data and the details before they can be used for any meaningful purposes. Much of the economic data available in India appears to be unreliable, often contradictory, and hence, they need to be called on with caution, lest the conclusions drawn be completely wrong.
The author is head of quantitative research practice at Aranca, a research, analytics and advisory firm based in Mumbai.
Plunging consumer demand could seriously impact manufacturing sector and dent overall economy.
A shift in a greater portion of India's unorganised economy to an organised space could skew GDP numbers.
According to 2011 Census data, unemployment was more than 15% among educated people.