India’s Two Speed Economy: The Widening Gap Between Consumption And Investment
The Indian economy is firing on a single cylinder --
consumption. Indians, particularly urban Indians, are spending well. That,
together with support from government spending, is keeping the economy afloat
even as investment remains conspicuously absent.
If anything, the gap between growth in consumption and investment seems to be widening rather than narrowing. The economy, as a whole, continues to grow at more than 7 percent although growth seems to have moderated based on the latest data.
Gross domestic product data for the first quarter of the current fiscal (FY17) released by the government on Wednesday showed that the economy grew at 7.1 percent in the April-June quarter, lower than the 7.9 percent growth in the proceeding quarter. In gross value added terms, the economy grew at 7.3 percent compared to 7.4 percent in the March- ended quarter.
Divergence Between Consumption And Investment
look at the expenditure side of the GDP data shows that a bulk of the heavy
lifting during the quarter was done by government spending, which rose a solid
18.7 percent. The increased government spending was supported by continued
growth in private final consumption expenditure, which rose at a pace of 6.7
percent over the same period last year. In stark contrast, gross fixed capital
formation contracted by 3.1 percent in the first quarter of the year, widening
the gap between investment growth and consumption growth.
divergence has now persisted for at least three years and has widened over the
last two quarters when investment contracted.
Between 2013-14 and 2015-16, private consumption growth remained steady above the 6 percent mark however growth in gross fixed capital formation tottered between 3-5 percent.
There was not much sign of investment demand recovery with gross fixed capital formation (GFCF) growth at (-)3.1% in Q1 FY17 (7.1 percent in Q1 FY16). Low capacity utilization, weak corporate balance sheets and limited fiscal room for continued capital expenditure continue to hint at protracted investment recovery cycle.Kotak Institutional Equities Note Published Thursday
Missing Drivers Of Investment
in the economy continues to be stymied by the ongoing process of deleveraging
of corporate balance sheets. While there has been some progress made in reducing
leverage, the proportion of stressed firms remains high.
to the Reserve Bank of India’s financial stability report released in June, the
proportion of leveraged companies in a sample of 2,600 listed non-government
non-financial companies fell to 14 percent in March 2016 compared to 19 percent in September last year. Leveraged companies are defined as those
that have a negative net worth and a debt-equity ratio of 2 and more.
A second constraint to investment remains the sub-par capacity utilisation seen across industry. The latest survey from the RBI released in August showed that capacity utilisation levels were at 74.1% in the fourth quarter of FY16, unchanged from levels seen in the fourth quarter of FY15.
As such, investment is expected to continue lagging consumption in the near term, as acknowledged even by the RBI. Over the medium term, the central bank expects investment to pick up as demand gets a boost from a good monsoon and pay commission awards.
...economic growth, while showing signs of picking up, is still below levels that the country is capable of. The key weakness is in investment, with private corporate investment subdued because of low capacity utilisation, and public investment slow in rolling out in some sectors.Outgoing RBI Governor Raghuram Rajan, in the RBI’s Annual Report 2016, released earlier this week.
Crisil Research, the research arm of the rating agency, expects that private investment will start to pick-up towards the end of this fiscal as consumption demand gets another push from a strong monsoon and the pay commission awards.
...private consumption demand will need to rise further to encourage private investment, which remains muted given excess capacity and high leverage. Demand is set to receive an impetus in fiscal 2017, given a normal monsoon, better public sector wages, and improved transmission of interest rates. Taken with the crowding-in effect from stepped-up public investment, private investment should rise towards the end of this fiscalCrisil Research Note Published Thursday
Case For Rate Cuts Remains Weak
potential economic growth could raise the pitch on calls for interest rate cuts
from certain stakeholders in the economy. The RBI, however, is unlikely to be
swayed. The central bank remains squarely focused on bringing down inflation to
5 percent by March 2017 and eventually to 4 percent.
retail inflation skirting the upper bound of its comfort level of 2-6 percent, room to
cut rates remains limited. Most analysts are expecting one more rate cut this
year but the RBI will likely wait until it sees a lower headline inflation
number before it pulls the trigger.
Besides, few can argue that investment is being held up by higher policy rates. The RBI has now cut its signalling repo rate by 150 basis points since the start of 2015. In response, the cost of borrowing through the bond markets has fallen to the lowest since 2009. Banks, though, have been slow to cut rates because of the pile of bad loans that are weighing on their bottom lines.
Given that, the RBI would rather focus on improved transmission of previous rate cuts and wait until inflation softens before announcing another reduction in the repo rate.
...inflation projections are still at the upper limits of RBI’s inflation objective. With the Reserve Bank needing to balance savers’ desire for positive real interest rates with corporate investors’ and retail borrowers’ need for low nominal borrowing rates, the room to cut policy rates can emerge only if inflation is projected to fall further.RBI Annual Report 2016