Palaniappan Chidambaram, former Union Minister of Finance, Harvard Business School alumnus, and currently under the microscope of the Enforcement Directorate in the INX Media money laundering case, took some time out to talk about the state of the Indian Economy. What Chidambaram’s views are; what the latest numbers in GDP growth indicate; is the Indian economy on the path of recovery post the twin blows of demonetization and GST; and what does GDP growth mean to the layperson that is you and me – these are the questions we are addressing on our Story of the Day. My name is Seetal, and you are listening to Moneycontrol.
P Chidambaram’s Views on the Current Indian Economy
Former Union Minister of Finance, P Chidambaram, speaking at an event organized by the Maharashtra Congress Unit in Thane, compared the Indian economy under PM Narendra Modi to every motorist’s nightmare – a car with three of its tyres punctured.
“Private investment, private consumption, exports, and government expenditure are four growth engines of an economy. It's like the four tyres of a car. If one or two tyres are punctured, it will slow down, but in our case, three tyres are punctured," he said in his scathing attack on the government, and indeed Narendra Modi. He also reiterated that the government is incompetent in addressing the economic issues, which he claimed has “worsened” under the current dispensation. Keen followers of Indian polity will remember a similar comment Chidambaram had made back in 2014 in an interview with the BBC – “What Modi knows about economics can be written on the back of a postage stamp.” Modi, then hoping to be the Prime Minister, had retorted using Gandhi. Modi invoked the Father of the Nation and said that according to the concept of trusteeship propounded by Gandhiji, those in power should act like trustees of public goods and not behave like owners. Admitting that he lacks the knowledge confined in books, Modi had then said he could always hire those who are well-versed with economic issues… and voila, since then we have had demonetization and GST.
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Cycling back to 2018, Chidambaram also had a few remarks about the GST implementation. “Post-demonetisation, this government has introduced GST with five tax slabs with a cess over it. In other countries, GST is just one tax system but we can have two types of taxation in India. Still, having five slabs is not what we had imagined about GST,” he said.
He also focused on the issue of government expenditure, claiming that it is only on healthcare and a few other amenities. He blamed the rising petrol, diesel, and LPG prices on poor handling of expenditure by the government. “To keep this expenditure going on, the government has continued taxing petrol, diesel and even LPG. It is squeezing money from people in such taxes and spending some from it on public amenities,” Chidambaram said. Did you see any investment in the power sector recently, he questioned. “For example, out of the 10 major companies that went into insolvency, five were steel companies. How can you expect any investment in such sectors,” he went on to say.
Claiming that India is not making money even in the exports arena, he invoked some numbers from his own term as Finance Minister. “Industrial utilisation is mere 60 per cent in the country. The export of merchandise, during the UPA was USD 315 billion, which was USD 303 billion last year. Before that, it was not even USD 300 billion. This shows we are not earning from exports either,” he said. The Pradhan Mantri Mudra Yojana didn’t escape his scrutiny either. Under the scheme, loans of upto Rs 10 lakh are provided to non-corporate, non-farm small/micro enterprises. Mocking it, Chidambaram said, “The average amount of disbursed Mudra loan is Rs 43,000 per person. No major investment can be done with such low amount, except if one wants to run a pakoda stall,” Chidambaram said in an apparent reference to Modi's (in)famous remarks that selling 'pakodas' is also a form of employment.
Chidambaram reserved his greatest concern not for the economy but for the social blunders made by the government. He thought that while the grave economic mistakes are still curable and correctable, the social changes as we’ve seen in the country, under the Modi government, may well be much more profound. “The BJP-led government has suddenly given a message to certain communities that they are second-rank citizens of this country. There is a lot of unrest over food habits, social behaviour, active anti-Romeo squads in the country,” Chidambaram concluded.
Scathing attacks on the government and the face of the government; comparison to how things were and how things ought to be; talking about prices and the concerns of the common man… Toto, we are not in 2018 anymore, we are firmly in the lead up to the 2019 general elections.
Meanwhile… India’s GDP Growth Story
Interestingly enough, Chidambaram’s attacks on the Modi government’s handling of the economy come immediately in the wake of a story that seems to indicate otherwise. The Central Statistics Office (CSO) comes bearing good news – the Indian economy grew 7.7% in the January-March quarter – the fastest in seven quarters – signaling a quick turnaround aided by rapid construction activity, consumer spending and corporate investment. This turnaround could indeed augur well for the Modi government seeking re-election come 2019.
The new estimates firmly cement India’s place as the fastest growing major economy, ahead of China’s 6.8 percent growth in the quarter-ended March. For the entire fiscal year 2017-18, India grew at 6.7 percent the government said in its new estimates on Thursday, marginally higher than the 6.6 percent expansion projected in February and slowest in the last four years. The economy saw growth rates of 5.6%, 6.3%, and 7% in the first three quarters of 2017-18, topping the year off now with 7.7%. There has certainly been an improvement in GDP growth quarter-on-quarter, but year-on-year, the GDP growth has been 6.7% - a tad higher than previously estimated – but also a tad lower than 7.1% seen in 2016-17, and definitely much lower than the 8.2% GDP growth seen in 2015-16. Quarter-on-quarter growth notwithstanding, this year-on-year growth of 6.7% is the slowest pace ever since Modi took office.
So let’s break this growth rate down a little bit.
First of all, we need to understand the differences between real GDP and nominal GDP. The main difference between nominal and real values is that real values are adjusted for inflation, while nominal values are not. As a result, nominal GDP will often appear higher than real GDP. So… the 6.7% growth we just reported – is that nominal or real? Well, that is real GDP. Economists and analysts tend to focus on real GDP to gauge economic activity, much more than they do on nominal GDP. But it is nominal GDP growth that truly drives a growth in household income as well as topline growth in corporate India. Where are we when it comes to nominal growth? We have good news there as well. The levels have come back up. Due to high inflation rates, India’s nominal GDP has always been in the double-digit range – about 10.7% to 13% in the four years to FY17. And then came some seismic events – demonetization and GST. First hit, demonetization. Real GDP, which was 7.6% in the second quarter of FY17, shrunk to 6.8% and 6.1% in Q3 and Q4 of FY17. Remonetisation came into effect, but at a sluggish pace.
Adding insult to injury, second hit – GST in July 2017 posed new challenges. Glitches in the GST network, lack of clarity about transitory provisions, and frequent changes to tariffs impeded business in the transition months between April and August. This forced many firms to pare inventories and go slow on sales during these months. That further slowed down real GDP growth to 5.6% in Q1 of FY18, and a slight uptick to 6.3% in Q2 of FY18.
What happened to nominal GDP then? A slip from the usual double-digit to single digit! With inflation moderating and growth slowing abruptly in the first half of 2018, nominal growth rates dipped from 10.7% in Q4 of FY17 to 8.3% and 9.5% in Q1 and Q2 of FY18.
Since then, the uptick trend has continued, and so have double-digits in nominal GDP. With inflation normalizing, and growth picking up, the last two quarters have seen nominal GDP growth return to 11%. That is good news for income earners as well as investors in Indian businesses.
Where are we seeing growth then?
We are seeing it in those sectors where growth had slowed down during the troubled times we spoke of earlier – job-creating sectors. Manufacturing, which saw GVA (gross value added) growth slip to 6.1% in Q4 FY17 has expanded by 9.1% in Q4 FY18. Construction, which shrank by 3.9%, grew by a hefty 11.5% in Q4 FY18. Trade, hotels, transport and communication, which slipped to 5.5% in Q4 FY17 has rebounded to 6.8%. Financial services and real estate, which flatlined in Q4 FY17, grew by 5% in this latest quarter.
Aarati Krishnan, writing for The Hindu, also points to a growth in investment. “For the last four years, analysts have fretted about stalled private investments holding back growth, with the two other legs — private consumption and government spending — doing much of the heavy lifting. This was attributed to high interest rates, excess capacities across industries and the high debt stockpile at India Inc. But the latest quarter has brought evidence of private investments coming back to life too, with Gross Fixed Capital Formation (GFCF) growth at 14.4%, improving steadily from 1% in Q1. Buoyant commodity prices, lower interest rates and dwindling corporate debt are likely to have driven this,” Krishnan went on to note.
PM Modi was positive about the trend. “We will sustain a growth of 7.5 to 8 percent per year,” Modi said while delivering a keynote address at the Shangri-La Dialogue. Finance Minister Piyush Goyal said the 7.7 per cent GDP growth showed the economy was on right track for higher growth in the future. Economic Affairs Secretary Subhash Chandra Garg said the government is not cutting its FY19 growth forecast of 7.5 per cent. Chandrajit Banerjee, director general, Confederation of Indian Industry (CII), said, “The rebound in growth reinforces CII’s own assessment that the economy is back on track and is set for a strong recovery after the period of disruptions sparked by demonetisation and GST implementation.”
Industry, and the private sector, also welcomed the uptick, and seemed hopeful of a turnaround in the economy, saying finally, the dark days of GST and demonetization may be behind us.
So. Key takeaways therefore are the following: the economy is recovering at a faster pace; the construction industry is re-emerging out of its slump; the impact of GST is fading gradually; investments are showing signs of steady recovery; manufacturing industry looks healthy; GFCF has grown – meaning corporate investment activity has increased; farm sector growth at 4.5% and set to grow further thanks to good monsoons.
So far so good.
G(O)DP Lies in the Details: What the Fine Print Says
So… this all sounds great. Is there a catch? Alas, there is.
The unseen catch is the “hand of the government,” as a report by HSBC went on to note. The economy, and the growth therein, are still heavily reliant on government spending. The fastest growing segment was not manufacturing or services, but ‘public administration, defence and other services’, a segment that expanded by 10% in FY18 on top of a 10.7% growth in FY17. ‘Public administration, defence and other services’ is but euphemism for the expenses incurred by the Central and State governments towards running their day-to-day work. GVA estimates at current prices of this item rose from INR16.6 lakh crore in FY16 to INR 22 lakh crore in FY18, as the implementation of the Seventh Pay Commission recommendations entailed higher salaries, HRA and other benefits to government staff. These massive payouts have clearly acted as a stimulus over the last three years, propping up consumer demand, aiding sales of goods and services, and thus feeding into GVA growth for both manufacturing and services. If we picked this item out, India’s real GVA expanded by a not-so-impressive 5.9% for FY18, and 6.6% in FY17.
According to the HSBC, “the hand of government” lifted GDP growth. The report cited four key drivers for the rise in growth print – core GVA (Gross Value Added), the public spending component of GVA, construction, and rise in central and state government fiscal deficits.
As per the report, core GVA (GVA excluding public services and agriculture), which is a rough proxy for private sector growth, moderated slightly in the March quarter to 7.2% versus 7% last quarter and 4.1% in the same quarter last year. “The GDP print reinforces our view that much of the current uptick in growth is led by the government's push to construction and consumption,” the HSBC report said. The report also went on to note – much like Chidambaram did – that India’s export growth has fallen across every metric even though global demand has been strong and that net exports have shaved off 1.5 ppt from the growth number.
According to HSBC, the public spending component of GVA and the government consumption component of GDP grew at a rapid pace, accounting for roughly one-fifth of overall growth. Moreover, construction and capital formation grew at double digits and public roads contracts awarded quadrupled in the March quarter. Additionally, central government fiscal deficit for FY18 rose to 3.5 per cent, versus a budget estimate of 3.3 per cent and this has growth dividends, the report noted.The growth may also be a case of favourable base effect.
While it is true that Gross Value Added (GVA) increased by 7.6% at constant prices in Q4 compared to 6.6% in Q3, we must remember that growth in Q3 was on top of 6.9% growth in the year-ago quarter, while growth in Q4 was on top of much lower 6% growth in the March 2017 quarter, a period severely affected by demonetisation. Almost all sectors—agriculture, manufacturing, trade, finance and construction—had the benefit of a lower base. “Trade, hotels, transport and communication etc” sector and the “financial, real estate and professional services” sector, despite having lower bases, have shown lower growth. Gaurav Kapur, chief economist at IndusInd Bank points out that growth in the private services sector (including construction) fell to 7.3% in Q4 from 8.1% in Q3. That may still be due to the remnant effects of GST and indicative of a not-yet full recovery.
Investment demand may be back with renewed vigour, but much of it is due to government spending, as we have already discussed.
The overall picture looks less rosy when we look at GDP and GVA growths at current prices. Our over-reliance on GDP, and the celebration of racing ahead of China, should come with some caution, explains Dipankar Dasgupta, writing for CNBC. Dasgupta, a professor of Economics at the Indian Statistical Institute, goes on note that what is essential is sustainable economic growth.
What Lies Immediately Ahead?
The looming threat ahead for India on its recovery phase is global oil prices. Rating agency Moody’s Investor Service delivered the first piece of bad news for the economy last Wednesday, when it cut its growth forecast for India for 2018-19 to 7.3% from 7.5% projected earlier, holding that higher oil prices and tighter financial conditions will weigh on the pace of growth acceleration.
The government has been helped by its high excise, customs and sales tax (GST) mop-ups. These have accounted for about 9% of the nominal GDP. Tax collections have been helped in no small measure by the very high duties on fuel, imposed at a time of falling oil prices. But those days of $55 a barrel are long gone, meaning, they are so last year. We are staring down the barrel of $68-70 a barrel now, and as the price to pump petrol or diesel goes up, pressure will mount on the government to roll back its duties to offer relief to consumers (aka voters in 2019 general elections). And if the government does indeed roll back duties, it will have to tighten the purse strings on both revenue and capital spending, i.e., the “hand of the government” we spoke of, which fed the GDP growth, will have to be drawn back. Meaning, that silent stimulus to the GDP will vanish.
Higher oil prices have already pressured the rupee, near a record low last week and Asia’s worst performer. Alongside, rising global trade tensions due to the imposition of import tariffs by the United States could moderate global trade growth, tempering Indian exports, analysts said. “We have cut our FY19 GDP forecast by 20 basis points taking into account rising oil prices and potential global trade wars,” said Teresa John, economist, Nirmal Bang Institutional Equities in Mumbai. Subhash Chandra Garg, the current Economic Affairs Secretary said high oil price will have a reasonable impact on the economy through a higher oil bill, current account deficit and consequential impact on behaviour of the foreign portfolio investors (FPIs).
While oil price-related concerns are very prevalent, there are those that think they might not impact the GDP growth story by that much. Hugo Erken of Rabobank International, widely thought of as one of the most accurate forecasters of India’s GDP, said that the domestic dynamics of India are “very strong” and “external volatility” won’t derail the current economic recovery. In its biannual World Economic Outlook, the IMF said economic activity in 2018-19 will be lifted by strong private consumption as well as the fading effects of the withdrawal of high-value currencies and implementation of GST. The International Monetary Fund expects economic growth could reach 7.4 percent in 2018/19.
Growth is also likely to get a boost from monsoon rains, which hit the southern state of Kerala a few days earlier than normal, potentially brightening the outlook for agricultural output. We have only recently done a podcast on the monsoons hitting Kerala where we have also discussed the economic implications of good versus bad monsoons. We encourage you to check that out as well. Needless to say, monsoons are India’s lifeline. They deliver about 70 percent of India’s annual rainfall and are the backbone of its $2.5 trillion economy, spurring farm output and boosting rural spending.
So, will Indian households continue spending at the rate they are? Will global oil prices force the government – with its eyes set on 2019 – to roll back duties, and in the process roll back its silent stimulus? Will Indian exports pick up the pace? Will the private sector pick up the pace in investments to compensate for the government going slow? These will determine the fate of GDP growth in the coming quarters, and indeed, the outcome of the general elections in 2019.