No surprise on GDP, but : Financial Express: 8th Febuary 2012

At 6.9%, the advance estimate of GDP for FY12 is not really a surprise, since we have sequentially lowered the

number from 9% in February 2011 at the time of the Budget to 7% in the last RBI outlook. The fact that it is lower than 7% is psychologically compelling as it brings the growth story down by another step. The stance that we are not that much affected by global economic developments, implying thereby that there is some kind of a decoupling working in the background, no longer holds.

The internals of this growth are quite hard hitting. Farm growth is going to be 2.5% despite the high foodgrain output projected by the ministry of agriculture. The number per se is good considering that it comes over a high base of last year, which was 7%. But the question really then is as to how much more can we improve on this number next year as farm trends have tended to be erratic at times.

Second, manufacturing growth of 3.9% is definitely on the lower side but this has been scaled downwards as the year has progressed due to responses to policy. Will there be a turnaround next year? The basic pre-requisites are the following: First there has to be a pick up in demand. Second, interest rates have to be congenial to enable investment. Third, fiscal policy has to be active and not overly cautious. It may sound clichéd here but government spending on infrastructure is necessary and the use of PPP model has to be hastened. Lastly, there are gestation lags before investment materialises into output. All this means that industrial growth in FY13 will be under pressure and the recovery will be gradual. The low base number will definitely help prop up this number.

Third, the services sector performance, which traditionally has been supportive with growth of 8-9%, has done a good job. It is a bit puzzling although that the trade, transport, communication and finance sectors have registered high growth rates at a time when the real sector is performing at low levels. The CSO has linked this growth with higher civil aviation traffic and telephone lines, which can only partly explain these numbers. Further, banking is to lead with high growth though the growth targets this year have been subdued with focus being on investing in government paper, as commercial demand is low due to growth conditions and high interest rates.

Fourth, the government’s contribution to GDP growth has been muted at 5.9%. This is worrisome because we have a situation today where the fiscal deficit has gone beyond the target and will probably be exceeded by over

100 bps. But, at the same time, we have not seen any definite stimulus for the economy through higher spending, which means that the focus has been more on transfer payments in the form of subsidies rather than project expenditure, which may have been compromised. In fact, curiously, project expenditure is probably the only component of the overall budget over which the government has control, which invariably faces the hammer when the chips are down.

Fifth, the worrisome factor is the declining investment rate that has come down from 30.8% in FY10 to 30.4% to 29.3 in FY12.

This is reflective of low growth in infrastructure and capital goods, both of which are needed to propel the economy.

Are there any messages for the coming year? With the elections going by, the government can get down to some serious thinking on the fiscal and monetary fronts. Inflation will continue to be an issue and the comfort we have today is not quite reassuring, given the latent inflation in the system. However, with easing of the rupee and global commodity prices remaining stable, it may be expected that the inflation rate will remain within range, so that RBI can work on the assumption of stability. The issue of course is when will RBI intervene to lower rates? It needs to be confident that there will not be a reversal in inflation and will pause till the first quarter of Q1-FY13 before taking such action.

The government, on the other hand, will have to take a lead role in two areas. The first is that all the pending legislations that have acted as barriers need to be resolved. The low hanging fruits such as land reforms, stance on environment, insurance and pension reforms are easier to take on, while broader issues like FDI in retail can wait. Where there is little controversy, one should logically go ahead and bring about change. The second is the Budget. While there are limitations in terms of the extent to which the government can increase its expenditure, given the obeisance to be paid to the FRBM rules, tax incentives on investment would be compelling. The Budget has to be made growth-oriented by providing the right incentives without hurting revenue. The tenets of the Laffer curve should be considered wherein incentives lead to higher output, which, in turn, will generate the revenue in the next few years.

Everything put together, indications are that FY13 will remain sober with few reasons to get excited as we inch towards the 7.5% mark, provided we keep our house in order. The Planning Commission will have to seriously take another look at its own projections and resources when looking ahead till 2017.