Ashima Goyal

Backdated GDP series and future growth

Ashima Goyal | Updated on January 06, 2019

Growth pangs Indian manufacturing is interest rate-sensitive   -  /iStockphoto

The new series data cannot really be faulted. But it is important not to repeat the policy mistakes that hit industrial growth

The 2011-12 base backdated GDP series led to much discussion. The reduction in past growth rates gave them a political colour. It is unfortunate if the independence of the CSO and associated experts is questioned just because of this coincidence. A rebasing that uses much richer datasets and aligns with international concepts must be welcomed.

Although many cynics would deny it, our institutions have become stronger and more expert driven as part of the maturing of the economy, improving the credibility of policy processes. Moreover, the 2011-12 figures give a jolt to both governments.

Growth rates in the UPA regime have fallen, but the sharp fall in growth after 2014-15 points towards adverse effects of some policy choices made by the current regime.

Stagnation in industry

Interesting implications for Indian growth can be drawn from the extended consistent series. First, the slowdown in growth pre- and post-2011 continues, although now it is milder. But the fall is very sharp in industry, where the pre- and post-2011 rates are 9 per cent and 6 per cent, respectively.

Industry has the maximum share in investment, which has been slow ever since 2011. There was a brief rise in 2014 but it collapsed again in 2015-16. After this long stagnation some supply side constraints must be appearing, so the current revival will not be a flashy infrastructure-led growth cycle but a slow, steady bottom-driven capacity expansion. To that extent it may be sustainable and imply the manufacturing upturn is robust.

But investment is sensitive to high real interest rates. The interest elasticity of consumer durables, housing and investment as well as working capital needs make manufacturing demand most sensitive to interest rates.

In 2015-16, as now, after the oil price crash of end 2014, under a forward-looking inflation targeting regime that overestimated future inflation, reduction in policy rates was inadequate, real interest rates were too high and investment and manufacturing collapsed. India’s net exports removing oil turned negative, implying a negative demand shock, which policy aggravated instead of alleviating. All this happened before demonetisation, which was implemented in November 2016.

Industrial growth became negative in the April 2015 quarter after oil prices crashed, exports slowed, and the real interest rate reached a peak of 4 per cent.

A sharp fall in growth of gross fixed capital formation followed in the July 2016 quarter. As a result of the slowdown in industry, India was not able to take advantage of the boom in world exports.

Rather imports increased, setting us up for problems with the current account deficit when oil prices rose again in 2018. Real rupee appreciation gave imports from China an additional advantage.

MPC attempt to repeat history

The above sequence should give us a dire warning, because again there is a nascent revival in investment and manufacturing. But oil prices have fallen and food inflation is also soft, so headline inflation is testing the lower bounds of the inflation target regime. Since there was no reduction in policy rates, real interest rates are much above neutral rates. The stance remains at calibrated tightening, preventing any cut. All this must change quickly. He who does not remember the past is condemned to repeat it.

The MPC wants to be forward looking but it also needs to be a bit backward looking. It was concerned about core CPI inflation at 6.2 per cent. But its mandated target is headline inflation, so it need not worry too much about transient rise in core inflation. Moreover, in the past core inflation has fallen whenever commodity price inflation fell. So being sufficiently backward as well as forward looking would have allowed the MPC to forecast the fall in core CPI to 5.7 per cent in November. More softening will follow since OPEC’s meeting revealed tensions in deciding on oil production cuts.

To argue that capacity utilisation is at a 10-year high (76.1 per cent in Q2 compared to the past average of 74.9 per cent) so the output gap is closed is not correct when industry growth has been low for 10 years; moreover 76 per cent is not a high rate of utilisation. Falling inflation indicates more correctly that aggregate demand is low in relation to capacity.

To say that bank credit growth at 15 per cent exceeds nominal income and is therefore adequate neglects the slowdown in credit from NBFCs. Credit growth to industry has turned positive finally but is still too low as banks now prefer to lend to the consumer.

The MPC still does not look at unemployment data, but it knows well India is far from full employment. The argument that high interest rates are required to improve savings and the current account deficit also neglects history. Savings to GDP ratios have steadily fallen in the current period of highest real interest rates. Household savings ratios fell from 19.9 in 2013-14 to 16 in 2016-17. They were at 23.6 in 2008-09 after a period of high growth. Savings rise with growth while interest rates affect the allocation more than the level. While some firms are cash-rich, they are not investing. The fall in household savings ratios followed that in investment and in growth and can reverse with a rise in the latter. Hopefully the MPC will now do some fresh thinking.

Falling capital output ratios

Apart from warnings, the back series also points to some positives for future growth. A major reason back-dated pre-2011 growth rates are lower, is lower service sector growth due to use of better data. But this same data show higher service sector growth after 2011. The Internet and smart phone related innovations taking place in India support such growth outcomes.

A higher share of services sector growth implies a lower capital-output ratio, which augurs well for future growth. It also answers the question of how measured growth can be relatively higher in the recent period although investment has slowed. The high investment before 2011 went into infrastructure assets many of which are stranded and have not delivered output.Since capital or capacity is less of a constraint in services, the slowdown in the quarterly trade and financial services points towards demand side constraints, and to credit constraints on NBFC loans.

Heeding lessons from past trends can usefully enhance future prospects.

The writer is a part-time member of EAC- PM. Views are personal

Published on January 06, 2019

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