The Economic Survey 2014-15 said that, India has reached a sweet spot – rare in the history of nations - is in which it could finally be launched on a double digit medium-term growth trajectory.” It also stated that,”in the short run, growth will receive a boost from lower oil prices,..” Every Investment analysts of repute and every analyst who has written a newspaper article or commented on TV, agrees that India has benefited greatly from recent changes in global economic environment. Further an over whelming majority of India analysts also agree that this is the major reason for a transformation of India’s external position (CAD) and the dramatic decline in inflation. This article shows that this is only one side of the external coin. The other negative side effect of the same external environment is the prolonged U shaped bottom that we observe in the Index of industrial production for manufacturing and the fluctuating fortunes of the corporate sector.
It is true that global oil and other commodity prices, collapsed in 2014. It is also true that the collapse of oil prices and related refined products and manufactures based on them have had very positive effect on the current account deficit and the Fiscal deficit. Contrary to popular analysis, the CPI inflation for Fuel in lighting actually accelerated during 2014-15 from 1.6% in October-December 2013 to 2.3% in Jan-March 2015. Worse, the same global fundamentals that led to the collapse of global commodity prices have had a deleterious effect on the World economy and the Indian corporate sector since the global crisis of 2008.
The story starts with world trade and GDP growth boom in the 2000s. This boom, almost a bubble in some respects, was exploded by the Global Financial crisis of 2008, leaving in its wake large excess capacities in the tradeable sectors of the World economy. World GDP growth, which averaged 3.1% to 3.2% during the 10-15 years ending 2008, collapsed to 2.0% in the following seven years to 2015. The nature of the bubble is better captured by the growth in world trade imports of goods and services. Rate of growth of World imports accelerated from an average of 5.8% per year in 1999-2003 to 7.8% per year in 2004-2008 and then collapsed to 3% per year during 2009-2013. World gross fixed investment grew at an average rate of 5.4% during 2003-2007, more than double the average growth of 2.5% during the previous five years, before collapsing. As in most recessions in the west, the globalized corporate sector tightened its belt and improved efficiency in the next few years, preserving its profitability, and even increasing it in some countries for a couple of years. The globalized parts of the Indian corporates sector did the same.
The corrective World-wide fiscal stimulus and monetary easing that followed the seizing of Global financial system at the end of 2008, led to a quick recovery in the developing and emerging market economies. But it had some effects that weren’t necessarily beneficial for all countries. This was partly due to short term focus and mistiming of policies. Many developed countries switched from a relaxed fiscal policy to a tightening one from 2010, instead of correcting the weak demand excess capacity problem in tradeable goods and services. This put an extra burden on Developed country Central banks at a time when monetary policy was already constrained by near zero interest rates. The commodity boom/bubble revived quickly after a temporary collapse at the end of 2008, and continued for several years beyond the World GDP & trade growth slowdown. It was finally pricked in 2014, as a credible announcement of an end to the US Feds Quantitative Easing (QE) laid the grounds for its collapse.
Some large emerging economies compounded the global excess capacity problem by continued investments through large risky injections of policy directed credit or expansionary fiscal policy or a fusion of both. For instance the rate of growth of China’s gross fixed investment declined only marginally from 13.4% per year during 2002 to 2007 to 12% per year during 2008 to 2013, while overall world GFCF collapsed from 4.6% to 1.8%. Consequently, the excess capacity in tradeable goods and services did not reduce and worsened for some products. This low demand and excess capacity meant low or non-existent opportunities for private capital in developed countries, driving it into commodity markets and keeping commodity prices booming.
Global Excess Capacity
The negative effects of the global demand deficit and excess capacity have affected different countries to different degree. The export oriented economies of China, East and South East Asia have been most severely affected. India, which has an export neutral economy, has been less affected overall. But India is a dual economy with a substantial part of its corporate sector globalized. A sub-index for this globalized sector, derived from the Index of Industrial production (IIP) for manufacturing, was in the last quarter of 2014, still below its level in the first quarter of 2011. Its average growth rate during the last four years was -0.3%, compared to an average growth rate of 3.1% for the non-globalized IIP sub index and 6.7% for the IIP for electricity. Part of the corporate sector and most of the non-corporate economy remains relatively isolated from the global cross-currents as suggested by the robust growth of electricity supply. The Motor vehicles sector, which is somewhat shielded from the global pressures, has also bottomed out and shows signs of recovery despite the negative effect of rising real rates of interest during 2014-15. The recovery of growth of private consumption (5.2%, 6.2%, 7.1%), gross fixed investment (-0.3%, 3.0%, 4.1%) and GDP (5.1%, 6.9%, 7.1%) in 2012-3, 2013-4 and 2014-5, shown by the new GDP series, is therefore consistent with the dual nature of the Indian economy.
One implication of the negative effect of the external environment on the corporate sector is the slower recovery in tax revenues. The corporate sector contributes tax revenues, not just directly as corporate income tax, but also through the income taxes paid by its employees and excise taxes collected by it (organized sector is important source of both). This negative revenue effect of the external recession has offset some of the positive effect of reduction in oil related subsidies on the fiscal deficit.
The external environment has therefore had both a positive and negative effect on the Indian economy. The negative effects of the global recession were felt immediately from the start of the global crises, but were masked by the temporary bubble created in India in 2010-11, through directed credit to PPP infrastructure contractors. These re-emerged with the pricking of the local Indian bubble. The positive effects of global recession on global commodity prices were delayed by global monetary expansion, but emerged in 2013-14 with the prospective end of US QE. Further the negative effects on the globalized sector have been magnified whenever the rupee appreciated in real effective exchange rate (REER 36 country) terms: Thus between September 2013 to April 2015 the REER appreciated by 11.4%, with the inevitable consequence on recovery
On balance therefore, the net effect of external factors on the Indian economy during 2014-15, has been clearly positive on the Current Account, mildly positive on the Fiscal Account and negative on corporate growth. The net overall effect is therefore positive, but much smaller than analysts have assumed so far.
Projections of Global growth by multilateral institutions like the IMF and the World Bank have proved since 2010 to be overoptimistic. They have been repeatedly revised downwards, as they have been most recently for 2015 and 2016. Interestingly, the IMF projections were always a little pessimistic for India and therefore turned out closer to actuals(old GDP series) than Government’s more optimistic forecasts for 2011 to 2013. Looking forward the slow recovery projected for the USA and EU will also mean slower recovery for India’s globalized corporate sector.[i] This does not mean, Indian macro-managers can do nothing about it.
A combination of looser monetary policy, a tighter fiscal policy with greater shift of fiscal expenditure from subsidies & consumption to infrastructure investment and a quick solution of the bankruptcy-bad loan problem can accelerate recovery of corporate investment, and accelerate overall growth.
Post Script (15/8/15)
A series of recent developments in China have exposed the extent of growth slowdown in China, previously hidden by the careful control that the CCP exercises over information. This means that in the short term the external environment will become more negative for India.
A number of reports have appeared over the past few years about empty apartment complexes and even empty cities in China. This and other indicators such as growth in electricity consumption, led several analysts (including us) to conclude that China’s actual growth was likely a per cent point below the officials numbers released by the Government i.e. around 6%. Recent developments suggest that the growth numbers, going forward, could be much lower, by about 1 to 2% below even this estimate of 6%, i.e. 4-5%. More seriously the panic reaction revealed by the use of draconian control methods to prop up the stock market in June and the shock devaluation in August suggest that the Communist Party (CCP) may have lost its ability to manage the economy and maintain a growth rate of around 6% (a much wanted soft landing). Consequently the probability of a decline in Chinese growth rate to 4-5% (feared hard landing) has now increased to 30%, from less than 10% in May this year.
Indian policy can minimize the adverse short term development s of Chinese hard landing by ensuring that the “Real effective exchange rate(36 country)” of the rupee does not appreciate (repeat not). Temporary measures to control any potential dumping by Chinese firms during the next year or so would also be justified, but these must be withdrawn once the immediate threat has passed.
In the medium-long term the reduction in profitability of investment, beginning to be revealed in the worsening profitability of foreign (FDI) firms operating in China, will also become visible in State and party controlled enterprises. With lower investible surpluses these State & party controlled firms will be forced to cut down their investment, and stop creating capacity that adds to global excess capacity in traded goods, particularly manufacturing. Over time this will help reduce excess capacity globally and benefit India and other countries suffering from an imbalance between effective global demand and subsidized capacity creation by China. In particular the globalized Indian corporate sector, producing standardize products such as metals and basic chemicals will benefit in the medium term.
A version of this article appeared on the Editorial page of the Indian Express, under the banner, “Inside, Outside, “ on June 6th , 2015, http://indianexpress.com/article/opinion/columns/inside-outside-4/ .
[i] Japanese growth has much less impact on Indian growth and Chinese growth has almost no impact on Indian growth. Chinese over investment in tradeable manufacturing will however, continue to have a negative impact on Indian manufacturing, whether China grows fast or slow.