The GDP Fine Print And What It Says About India’s Policy Options

India’s 5.8 percent GDP growth in the fourth quarter—a twenty-quarter low—seemed to shock many and prompted calls for steep rates cuts and easier liquidity conditions. In reality, the number was not out of the realm of expectations since estimates had ranged from a low of 5.7 percent to a high of 7 percent.

Still, a number close to the lower end of expectations, has prompted economists to call for another interest rate cut when India’s Monetary Policy Committee meets this week. This would take the cumulative rate cuts to 75 basis points in the first six months of the year. The benchmark repo rate currently stands at 6 percent and would be pegged down to 5.75 percent should the MPC vote in favour of lower rates.

This may very well happen but before sealing the call for a rate cut, it may be instructive to look through the fine print of the GDP data released on Friday.

Is Consumption Really That Weak?

Ahead of the GDP release, the concern was largely centered around consumption. High-frequency indicators, most notably auto sales and sales volumes of consumer non-durables, were among the factors responsible for those concerns.

The GDP data on Friday showed some decline in consumption but not one that was as stark as headlines had suggested. The pace of growth reported was also not significantly below the long run average growth in consumption that we have seen over the last few years.

Private final consumption expenditure grew at 7.2 percent year-on-year in the January-March quarter. This is lower than 8 percent growth in Q3 and 9.7 percent in Q2, but close to the 7.2 percent seen in Q1.

That’s not to suggest that consumption isn’t weak. Flat real output in the agricultural sector and nominal growth of just 3.8 percent are clear signals that at least rural demand is weak. Meanwhile, lower availability of finance may have impacted urban demand in some categories like consumer durables.

The point simply is that consumption demand was not the only cause for plummeting GDP growth. In fact, Motilal Oswal economists Nikhil Gupta and Yaswi Agrawal pointed out that total consumption (private + government) grew 8.1 percent year-on-year, better than the 7.9 percent in the previous quarter.

So, What Hurt Growth?

The real negative surprise came from investment.

Gross fixed capital formation grew just 3.6 percent in the fourth quarter of FY19, the lowest since the first quarter of FY18. There are a couple of factors skewing this number. First, the quarterly data is subject to an adverse base effect due to strong growth in the same quarter last year. Second, pre-election uncertainty could have had some impact on the quarterly data.

Still, it would be best not to dismiss the weakness in investment trends, particularly since improving capacity utilisation should actually have ensured continued strength in private investment. Should the weakness in investment persist, policy makers would need to study possible reasons for this.

Are corporations not convinced about the future growth prospects of the Indian economy? Are real interest rates too high? Or is India facing another bout of deleveraging at the promoter level, as highlighted by HDFC Bank economists Abheek Barua and Sakshi Gupta in a column written for BloombergQuint.

Confusing Signals From Sectoral Trends

The sectoral data threw up some predicable and some surprising trends.

For instance, it would have been fair to expect some weakness in the financial services segment due to the slowdown in disbursements from non-bank financial companies. Instead, financial services growth was strong at 9.5 percent, the highest it has been in at least the last two years.

In contrast, the trade, hotels and communications segment weakened with 6 percent growth reported compared to 6.9 percent in the third quarter.

The manufacturing sector, along with electricity, pulled down industrial growth. Manfacturing growth at 3.1 percent was the weakest link there.

And finally, the agriculture sector saw contraction of 0.1 percent in real terms. Ahead of the GDP release, Axis Bank economist Saugata Bhattacharya had forecast a contraction due to the decline in foodgrain output. In nominal terms, growth in the agriculture sector improved marginally since food prices have started to normalise.

What Should Be The Policy Response?

The study of the GDP data throws up the following insights:

• Consumption has weakened but not as sharply as feared.
• The strong run in investment has either seen a blip or a moderation, depending on how long it lasts.
• Certain sectors like automobile continue to drag down manufacturing.
• Weak agriculture growth remains an overhang on growth.

What do these insights say about the possible policy response?

First, agriculture growth needs to be tackled with some immediacy. The release of payments under the PM Kisan Yojana may help in pushing up rural demand and, in turn, rural inflation. Beyond that, the government may not have much fiscal space to boost growth, even though fiscal policy may be more effective in strengthening demand conditions. To be sure, it does have the option to use an ‘escape clause’ introduced in the latest version of the FRBM rules. This allows for a deviation of 50 basis points from the stated target.

Second, if urban consumption is hurting due to lower availability of finance, then easing liquidity conditions is more important than just announcing another interest rate cut. Easier liquidity will allow for better transmission of already announced rate cuts and, in fact, may lead to another de facto rate cut since the reverse repo rate will become the operative rate if liquidity is in surplus.

Third, if the RBI and MPC judge that the high real interest rates are hurting a revival in investment, even on the margin, then another repo rate cut should definitely be considered.

While inflation is normalising there appears little risk of it breaching the 4 (+/-2) percent range even in the next 12 months. In such a scenario, the MPC may need to (and have room to) provide a little more support to growth. That support may need to come through lower rates but also liquidity conditions that are in the neutral to mild surplus range.

The central bank need not drop all caution to do this. It could achieve this simply by rebalancing its priorities, as it has done often in the past. Only this time, it would need to do this within the framework of inflation targeting.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.