Growth conundrum

India’s latest GDP print pegging growth at 7.1 per cent for the second quarter of FY19 has significantly undershot expectations and dampened hopes that the economy is bouncing back strongly from the twin shocks of demonetisation and GST implementation last year. In the first quarter, GDP growth had surprised on the upside. It was underpinned by a notable 8 per cent expansion in Gross Value Added (GVA), stellar manufacturing growth of 13.5 per cent and relied less on government revenue expenditure to drive growth. But the trends have faltered on all three counts in the latest quarter. In the recent quarter, GVA growth has slumped to 6.9 per cent, manufacturing has lost momentum to 7.4 per cent and the government spend on public administration has picked up to expand by 10.9 per cent. With services such as trade, communication, financial services and real estate, India’s growth engines, also struggling at sub-7 per cent growth, it is quite clear why the latest update has had commentators trimming their India growth forecasts to below 7.5 per cent for the fiscal.

Apart from the absence of a favourable base effect which helped Q1 numbers, new headwinds to growth have also emerged this quarter. Industry and services faced a lag effect from the recent oil price spiral and depreciating rupee, pressuring profit margins at a time of weak pricing power. With bank credit to industry registering no growth this fiscal and bond markets short of liquidity, credit flow to businesses stalled too. With nominal growth in agriculture falling below real growth, deflationary trends in agri-commodities continue to cloud rural prospects. It is perhaps responding to this potent combination of shrinking farm incomes, muted inflation and modest wage growth in industry, that domestic consumers are now back in belt-tightening mode. Private Final Consumption Expenditure expanded by just 6.9 per cent in Q2 of FY19, down from 8.6 per cent in Q1. That consumption should slow just when the investment leg of the economy is getting back to double-digit growth, is bad news.

Overall, the latest GDP numbers, coming on top of the recent back-series lowering historical growth rates, suggest that the Indian economy still has a long way to go before it can aspire for potential GDP growth rates in the double-digits, which are critical to employment generation. Despite India’s leap in ease of doing business rankings, domestic businesses continue to face multiple challenges on the ground from high costs of capital, overactive regulators, infrastructural bottlenecks and usurious tax rates, not to speak of a high compliance burden. For the Centre, lower-than-expected GDP growth elevates the risk of the already high fiscal deficit overshooting its target. If such overshoot is inevitable, the Centre must ensure that the expenditure offers a counter-cyclical stimulus to the economy, by favouring capital over revenue spending. Alternatively, the Centre and States can directly put more money in the hands of consumers by lowering their high tax rates on fuel.

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