Time for course correction:

Time for course correction:

Context

Central Statistics Office (CSO) released the estimates of the gross domestic product (GDP) for

the first quarter (April – June) of 2017-18 and the growth rate has fallen below 6%.

What are the significant figures?

• In Q1 of 2017-18, GDP grew by 5.7% whereas the economy grew at 7.1% in 2016-17, Q4.
• The most disappointing aspect of the first quarter numbers is the steep fall in the growth rate of manufacturing to 1.2%
• Gross Value Added (GVA) at a basic price grew by 5.6% and the 2016-17 Q4 GVA growth was 6.6%.
• And the GDP and GVA growth for Q1 of the previous year stood at 7.9% and 7.6% respectively.
• Thus, on a yearly basis, there is a decline in the growth rate by almost 2 percentage points.

What accounts for the decline om growth rate?

• Most obvious factor is demonetization which had a negative impact on the growth rate
• Also, the destocking of goods which might have happened prior to the introduction of goods and services tax (GST) must have also had a negative impact.
• However, it would be unbefitting to attribute the entire decline of 2 percentage points to only to the aforementioned two factors.

Fall on Growth has been Steady and Continuous-

• What has been happening is a steady decline from the first quarter of 2016-17 when the growth rate of GVA was 7.6%.
• By the third quarter of 2016-17, the growth rate had declined to 6.7%.
• Since then it has fallen by another 0.9 percentage point.

What are the implications of this declined growth rate?

• Given the growth rate of 5.6% in Q1, it is unlikely that the growth rate for the year as a whole will exceed 6.5%.
• For this to happen, the growth rate in the next three quarters will have to be 7%
• The decline in the manufacturing sector if not revived soon, will have far reaching effect on the overall GDP figure.
• Because of the good monsoon, agriculture will do better. Since agricultural growth rate last year was also good, the increase may not be that much.

If the economy has to get back to the high growth rate seen earlier, we need to understand the factors that might have been operating to bring down the growth rate.

What are the other factors that are adding to the low growth rate?

• One of the arguments attributed to the low growth rate is the poor performance of the external sector.
• Growth is fueled broadly by two types of demand, domestic and external.
• India’s declining growth rate has also coincided with poor export performance.
  
• Export demand has been weak because of the lukewarm growth rate of the advanced economies.
• Again, the fall in the growth in the GDP value can be attributed to only to the poor export performance
• The fundamental problem has been the sharp fall in the investment rate.

• Gross fixed capital formation rate stood at 34.3% in 2011-12.
• This started falling steadily and touched 29.3% in 2015-16. It fell further to 27.1% in 2016-17.
• According to the latest numbers, in the first quarter of 2017-18, it stood at 27.5%.
• Since the public investment rate has not shown any decline (it stands at 7.5% of GDP), it is the decline in private investment, both corporate and households, that has been responsible for the steady fall.
• While the fall in corporate investment is steep compared to what was achieved in 2007-08, it has more or less stabilized at a lower level of around 13%.
• Household investment, however, has continued to decline even in recent years.
• Household here includes not only pure households but also unincorporated enterprises.
• Another intriguing factor about the falling investment rate is that the last few years have shown a steady and substantial increase in foreign direct investment (FDI).
• With this type of inflow and if the investment rate does not grow, the one surmise that one can make is that much of the FDI has gone into acquiring old assets rather than going to greenfield projects.
• All this implies that domestic investment has remained quite dormant.

Barring the period of post demonetization, there has been a rising trend of GDP growth. How would explain this trend given the falling investment rate?

• Growth can occur because of two reasons.
• One, it results from better utilization of existing capacity.
• Two, it can come out of new investment.
• Whatever growth we have been seeing recently has come out of better utilization of capacity rather than new investment.
• It is real growth spurred by new investment that generates more jobs.
• The growth that we have seen in recent years has not resulted in an increase in employment.
• The current period has therefore been described as one of ‘jobless growth’
• Firm data are available only for the organized sector. The rest are estimated through surveys. In fact, in the case of unorganized sectors, very often the position is one of ‘underemployment’ rather than unemployment

What can be done to stimulate private investment?

• First, in creating an appropriate investment climate, reforms play an important role.
• Some of the noteworthy changes that have happened in the last few years are the passing of the bankruptcy code and GST legislation, and modifications in FDI rules.
• Second, financing investment has taken a beating because of the poor health of banks.
• Banks in India today are universal banks providing both short-term and long-term credit.
• The sharp reduction in the flow of new credit has also put prospective investors in a difficult situation.
• To resolve the non-performing asset (NPA) problem, banks need to take a haircut.
• To bring banks back to good health, recapitalization has become urgent.
• The government should go beyond the amount indicated in the Budget regarding disinvestment and fund banks through the money raised by disinvestment.
• Third, a close look must be taken at stalled projects to see what can be done to revive those which are viable.
• This must be part of an overall effort to hold consultations in small groups with investors to understand and overcome the obstacles that come in the way of new investment.

•  Fourth, even though the progress of small and medium industries is very much dependent on the fortunes of the large, a separate look at medium and small enterprises may be needed to prod them into new investment.

What are the future prospects?

• To sum up, the growth rate in 2017-18 is unlikely to exceed 6.5%.
• Once the glitches and fears of the GST are over, the growth rate may pick up.
• Goal must be to achieve and sustain a growth rate of 8% and above over an extended period
• The core trouble factor is the steadily falling investment.
• However, there has been a slight pick-up in public investment recently
• That is not enough. Only when the two engines of public and private investment function at full throttle will India fly high.