The chart captures the monthly movement of IIP (index of industrial production) and core sector growth over the last one year. The core sector growth is a combination of 8 key infrastructure related sectors and accounts for ~41% of the IIP. The chart clearly indicates a positive correlation and a sharp fall into negative territory in the last two months. Of course, the September GDP will be officially announced only on November 30th but the data points are quite disconcerting. How low could the second quarter GDP go and what should be the policy response?
Why GDP could trend lower in September quarter?
- The biggest risk comes from the lead indicators and it is estimated that the number of lead indicators hinting at economic acceleration has more than halved in the last four quarters. In other words, the number of lead indicators hinting at an economic deceleration has nearly doubled in four quarters. The fall has been sharp in the last two quarters. It is estimated that Q2 could feel the pressure of decelerating indicators and also the lag effect of the first quarter, when GDP growth came in at 5%.
- Some of the high frequency indicators that have showed a sharp downturn include automobile sales, aviation numbers, construction activity and infrastructure investments and infrastructure growth as shown in the core sector numbers in the chart.
- The erratic monsoon (despite being above average) has impacted cropping, resulted in increased wastage and has also hit construction activity and cement demand. Ironically, the worst hit by erratic states was the agrarian states.
- World Bank and IMF have already downsized global growth and that is visible in India’s consistently lower exports and imports. With the trade deal still uncertain, that is likely to leave an imprint on Q2 GDP growth.
What is the policy response required?
The problems are well known and also adequately documented. The bigger challenge is the policy response. Here are the key challenges and the policy responses are critical if growth has to bounce back in the third and fourth quarters.
- One of the points emerging since the beginning of 2019 is that despite 135bps rate cut, there has been no perceptible improvement in GDP growth. There are two flaws in this assumption. Firstly, there is the concern that the rate cuts are not being transmitted to the borrower. Secondly, even after shifting to external benchmarking, when there is weak credit demand, it is unlikely to translate into growth.
- The RBI is likely to rely on further rate cuts as a policy response, but that could have slightly different repercussions. Retail credit has been expanding at a rapid pace and lower rates will only be instrumental in encouraging this credit binge. This could increase the risk of retail defaults and also give a push to consumer inflation.
- One response the government will have to look at is a counter-cyclical approach. The government needs to increase its tolerance to higher levels of fiscal deficit as percent of GDP. The fiscal push has already started with the Rs145,000 crore corporate tax cut push. However, that is only pushing profits and not impacting volume growth. That is only possible through greater spending by the government.
- The key messages from the IIP and Core sector data is that the constraints are not supply side but demand side. People just don’t want to spend although the sharp rise in equities and gold has generated a huge wealth effect in India. It is just that this wealth is not translating into spending. Like Japan of the 1990s, India is becoming an economy that is hardly spending despite access to cheap and easy credit.