Introduction
Indian GDP data
seems to have become a constantly evolving puzzle. In February 2015, Ruchir Sharma, Managing
Director and Head of Emerging Market Strategy, Morgan Stanly Investment
Management, wrote, “the dramatic upward revision of the GDP growth rate is a
bad joke, smashing India’s credibility and making its statistics bureau a
laughing stock in global financial circles” and “Nobody really believes that
the Indian economy grew at anywhere close to 7% last year, and shockingly no
one is willing to put an end to this nonsense.”[i]
I disagree strongly.[ii]
In my view, more
than 90% of World renowned analysts have failed to understand the Global
Financial Crisis (GFC) and its Impact on the World Economy. The GFC is a once
in a ¾ century event, the most significant since the “Great Depression” and not
just another post-war recession, or “great recession.” It has changed the
nature of many effects and correlations, at least temporarily. Non-recognition of this fact has led to
inadequate or wrong policies that have delayed the global recovery. This note
focuses on the Indian economy, and the change in co-relations between the Indian Corporate
sector and the overall economy.
Economic Growth
Since 2013-4 Indian GDP
growth has been on a gradually rising trend : From about 6.9% to about 7.3%
over 9 quarters. The latest data for the
first Quarter of 2015-16 at 7% (y-o-y) is below this two year trend. But two demand
side drivers of sustained recovery were above their trend lines in the first
quarter: Private Consumption growth has
trended from about 6.0% to about 6.7% and was at 7.4% in the first quarter,
significantly above the trend. Fixed
investment growth which has been virtually flat at 4%, grew at 4.9% (y-o-y),
significantly higher than in last eight quarters. These two factors give confidence that GDP will remain on trend for the rest of the
year, giving us a growth rate between 7.5% to 8% for the year 2015-16. Foreign trade is an area of concern as export
growth has been negative for the past four quarters and the reduction in
imports due to falling commodity prices may be exhausted by the end of the
year. Thus declining net exports could act as a drag on the economy. As I had warned in IE (June 6th,
2015), the external environment remains a drag on corporate investment and
growth recovery.[iii]
Corporate Decoupling
The opening of the Indian economy in the 1990s forced the Indian
corporate to compete and become stronger by building World scale plants and quality
products. Corporate investment and growth therefore led the India growth story
in the 2000s and was highly co-related with it.
The GFC has disturbed this co-relation, aided by misplaced notions of
fiscal austerity and “moral hazard” in Developed countries, by reducing global
demand dramatically. Non-market economy China, given its export-investment
growth model with 45%+ investment rates, continued to build new capacity in
tradable goods, unmindful of declining profitability. The consequent excess capacity
put increased pressure on the profits and reinvestment of the globalized Indian
corporate sector, once fiscal-monetary-ECB bubble of 2010-11 was pricked and
profit enhancing efficiency improvements were exhausted around 2012-13. Thus
the cyclical investment recovery that most analysts expected by 2013-14, has
been delayed further.[iv]
Policy Options
Though recovery of the globalized part of the corporate sector during
2015-16 is likely to depend on the
strength of the US economic recovery, other parts of the sector are more
intimately related to domestic policy. The shift in fiscal policy from
consumption & transfers to infrastructure investment will increase the
fiscal multiplier and raise demand for both infrastructure companies and
consumer durable companies. The acceleration of fixed investment growth in the
first quarter and the above trend growth of 6.9% of the construction sector are
suggestive. Falling inflation has raised
the real interest rates and thus tightened monetary policy. Restoring the real
interest rate to a level that accounts for a projected end year CPI inflation
of less than 5.5% will remove the policy constraints on growth of interest-sensitive
sectors like automobiles and real estate thus stimulating durables investment
and growth.[v]
The efforts to reduce “tax terrorism”
have smacked of two steps forward one step backward undermining the credibility
of government. The increase in paperwork linked to the black money bill or the misuse
of its draconian powers, could erode credibility further. Government, Central and State, must ensure that both on the tax front and on
“Ease of Doing Business” the changes reach down to the ground level where the
vast majority of business (tiny, small
and medium) operate. This will give greater
confidence to all business, including corporate and Foreign Direct investors to
accelerate investment plans.
China Uncertainty
Recent developments in China, were a shock
to those who believed that China’s CCP led economy is a market economy like any
of a 100 others. It was not a surprise to those analysts who have been
predicting a growth slowdown based on long term trends and/or knew the medium
term dangers of creating a credit fueled, investment bubble. However, even those who have been watching
for signs of economic slowdown (excess capacity in manufacturing & real
estate) below the officially revealed growth rate of 7%, were surprised by the quality
of economic management displayed in the creation & pricking of the China
stock market bubble. This loss of
invincibility will have more lasting impact than any short-term turmoil and
uncertainty created by it and the subsequent Yuan devaluation.
In the short term we need to watch out for dumping by stressed Chinese
firms, ensure that our real effective exchange rate doesn’t appreciate and
stick to our Revenue deficit targets to minimize vulnerability to shifts in
capital inflow-outflows. In the longer term a decline in China’s growth and
investment will reduce excess capacity in manufacturing and benefit India, and
we will benefit only if we pursue our reforms more effectively.
Conclusion
The Indian economy seems to be on a trend line
of slow, gradual recovery to a level of 7.5% growth. Attaining the potential
growth of 8.5% is only possible if Corporate profitability, internal resource
generation and investment growth revive.
This requires an implementation of the reforms announced in the last two
budgets, along with the macro-economic re-balancing measures outlined
above. It appears unlikely that the
economy can reach and sustain 8.5% growth without the Corporate sector
recovering its role as driver of fixed investment and productivity growth.[vi]
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A version of this article
appeared in the Indian Express, Editorial page on September 7, 2015 under the
banner, “Some Home economics”. http://indianexpress.com/article/opinion/columns/some-home-economics/
.
[ii] Indian Growth Puzzle, Policy Paper No. WsPP
3/2015, New Delhi, April 2015. https://docs.google.com/viewer?a=v&pid=sites&srcid=ZGVmYXVsdGRvbWFpbnxkcmFydmluZHZpcm1hbml8Z3g6NDg5YTE1ZDM5ZTU2MWNiMQ
[vi] “The J curve of Productivity and Growth:
Indian Manufacturing Post-Liberalization,” (with Danish Hashim) IMF Working
Paper, No WP/11/263. July, 2011. http://www.imf.org/external/pubs/cat/longres.aspx?sk=25029.0
.