Wednesday, March 11, 2015

Growth Puzzle Solved?


     The economic survey ably defined the puzzle that has been bothering Indian Macro economy watchers since the new GDP series with 2011-12 as base was published by the NAS, DOS. How can India be growing at 7.4% when corporate data (monthly IIP and Quarterly corporate results) indicate very low growth or stagnancy? However, neither the Economic Survey nor its author the Chief Economic Advisor provided an answer to the puzzle. After studying the new GDP data series for several weeks from every possible angle, I have come up with a possible answer to this puzzle. To answer this puzzle we have to reframe the question.  As the new data series is all we will have from 2014-15 onwards, assume that it is a correct reflection of the overall economy. Then the reframed question is can the overall economy grow so fast when corporate growth is so slow. The answer I came up with is yes. Here’s how.

Global Crisis and External Orientation

     In 2009-10 I gave a talk at the World Bank Institute, in which I argued that Export Oriented economies like China would be more adversely affected by the Global Financial Crises (of 2008) than neutral or domestic demand driven ones like India.[i] This was primarily because World trade was likely to grow at a much slower rate than earlier, and China’s exports would be additionally affected because it had become the largest exporter (not importer) in the World.
     If we refine this argument further, the same argument applies to the Globally integrated segments of economies with neutral external policies and even to economies that are primarily domestic demand oriented. Because of a legacy of bad policies (small scale reservation, labor laws, IDR Act) India’s economy is heavily segmented (Dualism) between a small organized sector, that consists primarily of large Public Limited companies and a large unorganized and informal sector which caters only to the domestic market. Since the liberalization of the 1990s, a substantial part of the former has gradually become globally integrated and globally competitive.  This part of the corporate sector, which produces tradable and/or traded products and services, which are of World quality, has been much more strongly affected, by World demand for tradable goods and seervices and excess capacity across the World, than we thought earlier.

  This is confirmed by several pieces of information. One piece of evidence comes from the new GDP data. This shows that the savings of private non-financial corporations has accelerated sharply from 13.2% in 2012-13 to 26.5% in 2013-14 (nominal) while inflation decelerated by about 1% (as measured by private consumption deflator), i.e. the growth rate more than doubled in real terms.  Over the same years, real investment by non-financial private companies decelerated from 14.8% (2012-13) to 6.4% (2013-14). Complaints from corporates about lack of demand for output, which appeared muted during 2013-14, became much louder during 2014-15, especially between the June 2014 budget and the February 2015 one, suggesting that the productivity gains that had kept profits and savings growing in 2012-13 and 2013-14, had been exhausted.  One would therefore expect profit growth from 2014-15 onwards to be driven largely by growth in demand and increased revenues. The expressions of concern about weak demand that arose during 2014-15 culminated in demands for fiscal expansion.
    This is also consistent with the reason given by the Department of Statistics, to explain the higher growth in the new series compared to the old: That the use of new Corporate data from the Companies Department showed that value added increased much faster than output (reflected in IIP data), because of productivity improvements in 2012-13 and 2013-14.

Domestic Oriented Economy

   The IIP which measures the output of the organized manufacturing, mining and electricity sectors, languishes at a growth rate of 1 to 3%. Similarly, quarterly corporate results indicate that the average growth performance of the listed corporate sector (Public Ltd companies) is still very weak. This is not due entirely to external factors.   Even within the corporate sector there are a number of segments besides those affected by global demand and excess capacity. These include largely non-tradable services like telecom, domestic air travel and real estate, natural resource industries like coal and iron ore and relatively protected sectors like automobiles that are less affected by global demand and excess capacity and more by domestic policies, legal and governance problems. This part of the organized/sector should show better performance once the known domestic legal, bureaucratic and governance problems are sorted out. However, when projecting into the future, one should keep in mind that even in globally competitive industries the same product at a different quality-price point is produced by the non-corporate sector and these (partial non-tradables) are not necessarily connected to or affected by global excess supply world quality goods. We have earlier seen that an unexpected slowdown in income growth tends to result in a shift in consumption from higher quality-price points to lower ones. Similarly the reverse tends to happen when income growth accelerates, though there is a lag which varies with perceptions of the longevity of slowdown or acceleration.

   In the light of this background the new GDP data shows that the growth recovery since 2013-14 is associated with, if not led by, a gradual acceleration in private consumption and Gross fixed investment. Thus GDP growth accelerated of 1.8% in 2013-14 (from 5.1% to 6.9%) was accompanied by an acceleration in Private final consumption by 0.7% (5.5% to 6.2%) and matched by an acceleration of 3.3% points in Gross fixed investment (-0.3% to 3%). Similarly the acceleration of GDP growth of 0,5% in 2014-15(to 7.4%) is led by a 0.9% point acceleration in Private consumption (to 7.1%) and a 1.1% point acceleration fixed investment (to 4.1%). The closing of the growth gap between overall GDP and private consumption, and the recovery of fixed investment suggests that growth acceleration can be sustained if the reform agenda outlined by the government is implemented.


    The puzzle of faster GDP growth (using revised data) and very slow organized/corporate growth can be explained by recourse to the extremely dualistic nature of the Indian economy. Collapse of global demand and excess capacity in tradable goods and services, have had a negative effect on the globally integrated and competitive sectors of all countries. In India this means certain high quality, high skill segments of the organized, corporate sector. Thus Indian corporate sector growth is likely to lag, rather than lead India’s growth recovery. However, the right macro-economic mix of tighter fiscal and much looser monetary policy (real repo rate of 0 to 0.5%) can stimulate the interest sensitive sectors of the economy like automobiles, housing and real estate, accelerating corporate recovery. Similarly, structural reforms such as mineral auctions can lift constraints on the mining sector mired in judicial-legal issues, giving an immediate boost, while measures to eliminate the jungle of laws and controls(Ease of doing business) percolate slowly to the ground level.

A shorter version of this note can be seen at ET Blogs, 

[i]   “Global Crisis: Impact on Growth Strategies”, Co-lead Presentation at the, Development Debate on Export Competitiveness, Korea Development Institute-World Bank Institute(WBI), Seoul Korea, March 10, 2010. .


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