The performance of the Indian economy has been quite enigmatic in the past two-three years. Two successive years of low growth cast a shadow on our growth potential and we went around looking for reasons. Policy paralysis dramatized the issue and remained embedded in our minds. The cabinet committee on investment under the United Progressive Alliance government cleared as much as over `6 trillion worth of investment by February. Yet, growth remained anaemic. We then said that we need reforms and there was some movement on land reforms and foreign direct investment in retail. Then the central government changed. Clearances have continued and the administration has been made to take decisions. Yet, the economic situation is at best stable, although sentiment is sanguine. Are we missing something?
An analysis of the growth path since 2011-12 shows slowdown has been due to a series of issues in which the government plays only a secondary role. The main issue has been with demand, where the level of spending has come down. The three major components: consumption, investment and government have shown limited traction.
While consumption numbers have increased, it has been more on account of food items rather than consumer durable goods, which, in a way, is a trigger for industrial growth. Growth in consumer durable goods for instance was 2.6% and 2.0% in 2011-12 and 2012-13 respectively, and then declined by 12.2% in 2013-14 and further by 12.6% in the first half of 2014-15. Clearly, households are not spending on non-food items. The reason is not hard to guess. Food inflation has eroded the spending power, as Consumer Price Index (CPI) inflation has been high averaging 10.2% in 2012-13, 9.5% in 2013-14 and 7.4% in 2014-15 (up to October).
Investment has been down over the years, with gross capital formation at current prices coming down from 30.6% in 2011-12 to 28.5% in first half of 2014-15. Two reasons can explain this phenomenon. The first is that investment in infrastructure has come down which, in turn, is due to two reasons. One, the stalled projects on account of policy impediments and bureaucratic red tape and fear of future retribution and (to an extent) reduction in government spending. Two, the prevalence of high interest rates has affected the feasibility of several projects.
The second reason for the decline in overall investment in the economy is that industry has cut back on investment. This is mainly due to surplus capacity with the average capacity utilization rate coming down from 77.7% in first quarter if 2011-12 to 70.2% in the June quarter if 2014-15. Quite clearly, low consumer demand translates into lower demand for intermediate, basic and capital goods. Add to that the surplus capacity in a high interest rate environment and investment is bound to be curtailed.
The third component of overall demand in the economy—government expenditure—has been under pressure in the last two years. It will probably continue to remain constrained in the current financial year as well since revenue has not accrued as budgeted primarily because growth projections have not materialized as yet. This has forced cuts in project expenditure. Such expenditure cuts have ranged between `38,000-`40,000 crore in 2012-13 and 2013-14. This in turn, has affected industry due to backward linkages. The present stance on the deficit is to pursue the Fiscal Responsibility and Budget Management Act path and restrict the fiscal deficit to 4.1% of gross domestic product for 2014-15. Therefore, chances of pump-priming by the government are low. In fact, with the fiscal deficit already touching the 90% mark for the fiscal year in October, further cuts in expenditure can’t be ruled out.
Low growth may thus be viewed as an issue of reduced demand caused largely by high inflation and controversies that impeded decision-making. The National Democratic Alliance government has considerably improved decision-making but ground realities are yet to change.
Demand revival would be a gradual process as even though CPI inflation came down to 5.5% in October, prices are still rising and that it is only the rate of increase that has slowed down. In fact, from 2011-12 onwards till September, total compounded inflation has been close to 40%, which has hit household budgets hard.
Therefore, while governmental action has assuaged sentiment, the fundamentals would take time to turn around. Interest rate cuts will help to a limited extent as a series of rate cuts would be required to revive fresh infrastructure projects. Further, certain policies such as those concerning labour, land and environment continue to be stumbling blocks.
These cannot be addressed easily given the legislative processes and political equations. The decline in global crude oil prices has been fortuitous and extremely beneficial for the economy not just from the point of view of inflation but also in terms of keeping the rupee stable and lowering the pressure on the fuel subsidy bill. But, it is important to recognize that the government is only an enabler of growth and not a reason when it decides to follow fiscal austerity. Getting all the pieces together for growth such as consumption, investment, reforms, administration and interest rates, surely takes time.
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