Forecasting economic growth has never been a precise science, and in recent times it has gone topsy-turvy, with the Indian economy making a mockery of econometric models developed by key institutions.
The monetary policy committee (MPC) of the Reserve Bank of India in its fourth bi-monthly policy slashed India’s GDP growth forecast by 80 bps from 6.9% to 6.1% during FY’20. A number of multilateral agencies and domestic private institutions have echoed a similar revision and lowered the GDP estimation for India.
Even if we take into consideration the RBI’s quarterly forecast, it is imperative to note that the central bank expects GDP to grow by at least 7% in both Q3 and Q4 respectively to arrive at an average of 6.1% in FY’20.
So this leaves us with the larger question to ponder as to whether the economy could see some green shoots in the second half of the fiscal, given a mix of monetary and fiscal measures undertaken recently.
Can consumption support growth?
Consumption, which accounts for almost 60% of India’s domestic economy, is one of the indispensable cylinders which buttress growth.
The following chart, which only looks at the year-on-year growth in the last two quarters of the previous seven years of overall GDP growth and consumption growth, shows that the growth in private final consumption expenditure (PFCE) has outpaced overall GDP growth in ten of the previous 14 quarters.
This validates the important role played by consumption growth in supporting economic growth in the second half of the fiscal.
Chart 1: Overall GDP growth and growth in PFCE during Q3 and Q4 of previous years (%)
The second half of the fiscal has been kick-started with consumers being lured to purchase commodities, incentivised by steeper discounts/cashbacks and bank messages to avail loan facilities.
With Q3 of any fiscal being the festive season in India, consumers usually prefer to make purchases during this auspicious time. Flipkart and Amazon, in the first edition of their holiday season, have supposedly registered gross merchandise sales of Rs 19,000 crore and are expecting close to Rs 40,000 crore in the coming months.
Retail loans from the banks will also aid in driving consumption. NPAs in this segment are low, as salaried individuals usually make timely repayments, so banks are confident to lend to such individuals.
Incremental bank credit during the August to March period during the previous six years have been robust and will be essential in driving consumption.
Chart 2: Growth in bank retail loans (%)
Investment deficit and liquidity surplus
The investment rate (gross fixed capital formation as a % of GDP) in the economy saw a marginal pick-up in the first quarter of FY’20 to 29.7% from 27.9% a quarter ago. Data from CMIE has also shown contraction in both new projects announced and completed projects during the first two quarters of this fiscal.
This can be corroborated from the flow of funds from the banks (“non-food credit only”) to the commercial sector during April to mid-September 2019 which has registered negative flows of around Rs 93,000 crore as against a positive flow of Rs 1,65,000 crore in the corresponding period a year ago. Though the cumulative bond issuances have been higher in the first half of this fiscal from the previous year, more than 70% of the funding is ramped up by the financial sector with only one-fourth share of issuances by the non-financial sector.
What is important to note is that fundraising for investment projects from the banks has been a problem not because of liquidity constraints in the banking system, but primarily because of the high risk component attached to investment projects. The banking system is flush with liquidity in recent months, with the RBI undertaking reverse repo transactions of more than Rs 2 lakh crore on a daily basis, which at least assures the banks unequivocal returns. The infrastructure, export and corporate tax measures by the government, to prop up investment, are supply side measures and will only gradually support the economy.
Rules vs discretion
The slowdown brings into perspective rule-based vs discretionary policies as a response. India’s central bank follows an inflationary targeting rule while the Fiscal Responsibility Management Act (FRBM) has mandated a gradual reduction of fiscal deficit (as a % of GDP) to 3% for the Central government. With upside risks to inflation limited, there has been some discretion which the central bank has undertaken to allay the growth concerns. The government has been largely committed to this fiscal rule, but the adherence to the target this fiscal would be a challenge given the measures announced.
As both Ajit Karnik, professor of economics at Middlesex University and Maitreesh Ghatak, professor of economics at the London School of Economics have highlighted, the Narendra Modi government has heavily embraced supply-side measures to address what is a demand-side problem.
One of those measures, the corporate tax rate cut, is adversely going to affect the government’s topline and consequently could hamper government expenditure (“the G in the popularly GDP equation”). Relatively more discretion on addressing demand side concerns by improving purchasing power or higher capital expenditure would have had better multiplier effects. Therefore, discretionary additional government spending would remain capped and won’t assist much in the revival in the second half of the fiscal year. In the meantime, the government could apply Robert Shiller’s idea of “narrative economics” and hope for positive story-telling to drive individual and collective human behaviour and lessen the impact of this ‘growth recession’.
With domestic conditions largely dependent on consumption for amelioration, external demand largely depends on oil dynamics and trade uncertainties. All in all, barring the statistical base effect, the revival in components of GDP will take time. Companies will have to lure consumers and improve consumer confidence to drive consumption in the economy in H2-FY’20. However, the other components should play second fiddle to consumption in H2 as the impact of the policy responses will be more gradual.
Sushant Hede is an Associate Economist at CARE Ratings. Views expressed here are personal.