What is behind the GDP growth falling to 5%

Even as the Centre’s big bank mergers detracted the attention briefly from the much-awaited GDP growth numbers for the April-June quarter, the sharp slowdown drew the market’s attention back to the immediate issue at hand. The Central Statics Office (CSO) revealing that the real GDP growth in Q1 of the current fiscal plunged to a six-year low of 5 per cent, is a big cause for worry.

Read more:India's GDP growth slumps to 5% in April-June quarter

The slowdown has been across most segments — mining, manufacturing, and construction — as indicated by the index of industrial production (IIP) data too. The sharp slowdown in financial, real estate and professional services and private final consumption on the expenditure side, is particularly worrisome.

Remember, the Economic Survey had painted a somewhat sanguine picture of the state of the economy, pegging the growth of the economy at 7 per cent (real GDP) for FY20, slightly higher than the 6.8 per cent in FY19. While this seemed optimistic even then, after the CSO’s Q1 GDP numbers, the RBI’s marked-down growth estimate of 6.9 per cent also seems way off the mark.

The real GDP growth this fiscal is likely to end at 6-6.2 per cent, stressing the need for urgent structural reforms by the government.

Sharp blow

The GDP growth had already fallen sharply in the March quarter of FY19 to 5.8 per cent - a 20-quarter low. The growth in Q1 of FY20 has slipped further, coming way below most estimates.

The GVA (gross value added) growth in mining fell to 2.7 per cent from 4.2 per cent in the March quarter, while manufacturing was flat as against 3 per cent growth in the March quarter and a much higher 12 per cent growth in the Q1 of last fiscal. Financial, real estate and professional services fell even more sharply to 5.9 per cent from 9.5 per cent in the March quarter.

The index of industrial production (IIP) has been alluding to the slowdown in Q1, as consumer durables and capital goods production contracted in the April-June quarter.

While agriculture GVA slowed to 2 per cent from 5 per cent last year, sequentially there has been some uptick, possibly because of the uptick in prices as evident in the CPI inflation basket too. Surprisingly, the agriculture GVA in nominal terms has seen a far greater increase to 7.9 per cent from 3.8 per cent in the March quarter, indicating improving prices. However it needs to be seen if the low base and higher prices aid growth in the subsequent quarters.

Of particular worry has been the steep fall in growth of gross fixed capital formation. In the March quarter it had fallen sharply to 3.6 per cent (from 11-13 per cent in the previous quarters). In the Apr-June quarter, the growth has inched up to 4 per cent but is still lacklustre, given that this component has grown by 9-10 per cent in the past three fiscals.

The sharp fall in consumption is a graver issue, given that consumption has accounted for 55-58 per cent of GDP. Remember consumption is at the core of domestic demand in India and hence the sharp fall in private final consumption expenditure from 7.2 per cent in the March quarter to 3.1 per cent in the June quarter, needs immediate attention.

A look at the sectoral deployment of credit statistics shows that credit to consumer durables shrunk by a whopping 71 per cent as of June. Vehicle loan growth has slowed considerably to 5 per cent. The capex cycle also continues to remain subdued - credit growth to industry is still single-digits.

Nominal GDP plummets

While the real GDP growth has fallen from 8 per cent last year to 5 per cent this fiscal in the Apr-June quarter, the sharp fall in nominal GDP growth from 12.6 per cent to 8 per cent during this period, is worrisome.

The GDP deflator (growth in ratio of nominal to real GDP) — another measure of inflation — has fallen from 4.3 per cent last year to 2.8 per cent currently. If high inflation hurts consumers, low inflation also has an impact on India Inc. and consumers. While falling food prices hurt agriculture income and spending, overall inflation also has a bearing on the wage growth and income levels across industries. Nominal GDP, also decides the credit requirement of a corporate, and hence impacts the growth in bank credit. CPI inflation has fallen from 7.4 per cent levels five years ago to 3.per cent recently.

Also, the Centre has managed to retain a comforting 3.3 per cent on fiscal deficit, by assuming a 11 per cent growth in nominal GDP growth for FY20 (from CSO’s FY19 estimates). Given the current sharp slowdown in growth and the underlying trend in inflation, such growth appears a tall task. The subdued growth is already impacting tax revenues for the government. While the additional surplus from the RBI can help, further slowdown in the economy could spell bad news for the fiscal deficit target - more so given that the pressure on the government to spend to revive sagging demand has only increased.

Bank merger a worry

The recently announced big bang mergers within the PSU Bank space will hurt credit growth further. At a time when growth in the economy needs the banking system to ramp up lending activity, the bank mergers can only cause more disruption. Given that the immediate attention will be to focus on the integration process, bankers will mostly look at consolidation of loan book and containing asset quality rather than scale up lending.

The RBI cutting rates and banks lower lending rates may help credit growth. But uncertainty in the jobs market and growing wariness among borrowers, are key dampeners that can impede credit growth.

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