The Pak Banker

Current challenges to growth, and long-term constraint­s

- Sudipto Mundle

The first advance estimate of gross domestic product (GDP) released earlier this month projected that GDP would grow by 6.5% in 2017-18, slower than the 7.1% growth recorded in 2016-17. This seemed to suggest that the growth cycle was still in a declining mode, battered by the twin shocks of demonetiza­tion and the goods and services tax (GST). However, that interpreta­tion is misleading in my view. The first advance estimate of GDP is based on data covering only the first six or seven months of the financial year, which absorbed the worst of the twin shocks. Moreover, it masks changes that are visible only with higher frequency data.

In my previous column (goo.gl/3huVcw), I had suggested that the growth cycle had bottomed out and moved on to a recovery phase. Quarterly growth, which had been persistent­ly declining for the previous five quarters till Q1 of 2016-17, had finally turned around to 6.3% in Q2. Further, this was backed by a turn around in gross fixed capital formation (GFCF), a critical growth driver. Though modest at 4.7%, this was higher than the growth of GFCF during the previous four quarters.

I am happy to note that the advance estimate of GDP actually reinforces my conjecture. Implicit in the 6.5% annual forecast is a quarterly growth rate of 7% during the third and fourth quarters, implying that the growth recovery has now persisted for four successive quarters. The advance estimates indicate that GFCF growth has also gone up from only 2.4% in 2016-17 to 4.5% in 2017-18. This is still very low, reflected in an investment rate (GFCF/GDP) that is still declining. But it does mark an increase in investment growth, which had been persistent­ly declining for several quarters till Q1 of 2017-18. This turnaround of the investment cycle, however weak, is quite significan­t because investment is the most important autonomous driver of growth in a trade deficit economy.

Thus, while some segments of the economy like real estate and the unorganize­d sector are still in the doldrums, and a crisis persists in agricultur­e, the economy as a whole seems to have got over the twin shocks and finally moved on to a recovery path. Moreover, the Central Statistica­l Organizati­on's advance estimate is somewhat lower than the projection­s of the Reserve Bank of India, the Internatio­nal Monetary Fund and other multilater­al or private organizati­ons, which forecast a growth rate of 6.7% or more for 2017-18. If the upturn of quarterly growth persists, it is quite possible that growth in 2018-19 will exceed 7%.

That being said, these observatio­ns are neverthele­ss conjecture­s. Actual outcomes going forward will depend on a host of policy interventi­ons and exogenous factors. On the policy front, the adverse impact of demonetiza­tion seems to be behind us, as already noted. However, it should be emphasized that this applies to output growth, not employment. The share of the unorganize­d sector, including agricultur­e, is much larger in employment than in output. Hence, while output growth is recovering despite the persisting crisis in this sector, it is unlikely that there is any similar recovery in employment.

The GST is quite another story. Its poor design and the inept roll-out without adequate administra­tive and technical preparatio­n, especially for the online goods and services tax network (GSTN) platform, caused a great deal of confusion and imposed an enormous compliance burden on the tax payer. But fundamenta­lly, the introducti­on of the GST is a major progressiv­e reform of India's tax system. As the initial design is rationaliz­ed and implementa­tion problems are ironed out, the benefits of a huge common market with a unified indirect tax system will have a strong positive impact on growth. The ongoing deliberati­ons of the Modi Committee on direct taxes are also expected to be reflected in a simplified and more effective direct tax system, possibly even in the forthcomin­g budget, with a further positive impact on growth.

In the financial sector, the government is finally coming to grips with the problem of excessivel­y leveraged corporates and excessive levels of non-performing loans, especially in public sector banks. This has been the principal factor underlying the growth slowdown and stagnation of private investment. Recapitali­zation schemes for banks, combined with implementa­tion of the new Insolvency and Bankruptcy Code, could give a strong push to private investment and growth.

This is a major constraint for the Indian economy in competing in the global market even at present, as reflected in its low share of global trade. How it would compete and sustain high growth in a world of rapidly changing, disruptive technologi­es such as robotics and Artificial Intelligen­ce with such a workforce is hard to imagine.

 ??  ?? Quarterly growth, which had been persistent­ly declining for the previous five quarters till Q1 of 2016-17, had finally turned around to 6.3% in Q2. Further, this was backed by a turn around in gross fixed capital formation (GFCF), a critical
growth...
Quarterly growth, which had been persistent­ly declining for the previous five quarters till Q1 of 2016-17, had finally turned around to 6.3% in Q2. Further, this was backed by a turn around in gross fixed capital formation (GFCF), a critical growth...

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