Sunday, September 6, 2015

Indian Economic Growth: Post GFC


    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.


 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]
A version of this article appeared in the Indian Express, Editorial page on September 7, 2015 under the banner, “Some Home economics”.  .

[ii]  Indian Growth Puzzle, Policy Paper No. WsPP 3/2015, New Delhi, April 2015.
[vi]  “The J curve of Productivity and Growth: Indian Manufacturing Post-Liberalization,” (with Danish Hashim) IMF Working Paper, No WP/11/263.  July, 2011. .


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