India’s GDP growth recovered to 6.3% in 2QFY18 from a three-year low of 5.7% in 1QFY18. On the supply side, the growth recovery came on the back of a rebound in manufacturing activity to 7% from 1.2% in 1QFY18. Services growth however decelerated significantly to 7.1% from 8.7% over the same period. Agriculture growth also remained muted (1.7%yoy) on the back of high base effect.
The dichotomy in manufacturing IIP and manufacturing GVA numbers needs to be investigated. IIP manufacturing grew at 2.2% in 2QFY18 compared to GVA manufacturing growth of 7.0%. Manufacturing IIP is represents output/volume of production while GVA indicates value addition (output minus input prices). Thus GVA can be positive even if volumes are not growing only due to a fall in input prices. The divergence could also be explained by the methodology of data collection. GVA manufacturing data is estimated using IIP as well as advance filing of corporate accounts. The latter accounts for almost two third of manufacturing GVA. Thus GVA manufacturing is skewed towards larger firms as smaller firms do not need to file their financials every quarter.
The IIP data so far paints a dismal picture. 13 out of 23 industries in the manufacturing index have witnessed de-growth. These include key industries like – apparel, textiles, rubber and plastic, mineral products, electric equipment, furniture, leather, paper, wood products. Industries which have witnessed strong growth are – pharma, chemicals, computer and electronics, motor vehicles and transport equipment. Only a select few items like digestive enzymes and antacids, steroids, anti-psychotic drugs, anti-cancer drugs, IV fluids and capsules are driving growth in consumer non-durables category. Together these items account for almost one-third of the consumer non-durables category. There doesn’t seem to be any broad based increase in pharma exports except in the last two months. In case this is on account of increased domestic consumption, it is not a healthy sign for sure. With regards to consumer durables, the slowdown is broad based across categories. However, some seasonal items like air coolers and electric heaters have shown a strong growth.
The silver lining is that the green shoots of recovery are visible in the high frequency indicators. Consumption on the demand side and services on the supply side are the only ones driving the recovery. Auto sales grew at a double digit pace post GST rollout before cooling in October on account of inventory re-adjustment and hike in GST cess. A broad based surge in imports across various categories like electronic goods, gold, machinery and transport equipment etc. indicate that consumption hasn’t been severely impacted. This may be pointing towards a substitution trend – domestically produced goods with imported ones. Other consumption indicators like consumer credit, airline passenger traffic, foreign tourist arrivals, domestic tourism spending, are also showing signs of recovery. Services PMI has also inched up to 51.7 in October after rebounding from below 50 levels in July-August. These indicators suggest the effects of demonetization and GST are wearing off.
On the investment side, there seems to be some recovery as fixed investment grew by 4.7% in 2QFY18 up from 1.6% in the previous quarter as a percentage of GDP, there was a decline of almost 1 percentage point. Moreover, according to the latest data from the Centre for Monitoring Indian Economy, newly announced projects at Rs. 845 billion is at a four-year low. Value of stalled projects has risen for a fifth straight quarter to a record Rs 13.22 trillion in September quarter. The private sector accounts for more than two-thirds of the value of these stalled infrastructure projects and the number of new private sector projects announced in the latest quarter, is at a 13-year low. Manufacturing and electricity projects lead the way in terms of projects stalled.
The slowdown in growth has been on the back of two shocks in the past twelve months – a demand side shock in the form of demonetization and supply shock in the form of GST. To counter the impact of these two negative shocks, the government tried to give two positive shocks to the economy – bank recapitalization to fuel lending and Bharatmala to boost infrastructure spending. Will the two shocks revive growth going forward?
First, the government approved a state bank recapitalization plan of Rs. 2.11 trillion rupees (over the next two years). Details as to how this would be implemented – which bank and how much capital – are yet to be shared. This may fix the problem at the bank’s end, but a hugely indebted corporate sector may not borrow until demand picks up exponentially and capacity utilization levels increase beyond 80%. Low levels of capacity utilization across industries has hindered fresh capex. Capacity utilization have been below 75% for the last 3 years. The story remains that corporates are unwilling to borrow. And banks which are still a major source (almost 50%) of private sector borrowing are wary of lending. This is evident in the contraction in industrial credit since the second half of fiscal 2016.
The situation is similar to a Japanese type balance sheet recession. As corporate balance sheets are stressed, the transmission mechanism between lower interest rates and real economy has broken down. Corporates chose to minimize debt instead of maximizing profits when interest rates fell. Corporate deleveraging though underway will progress at a slow pace. Moreover, with inflation inching up, interest rates are not expected to come down further. The impact of low input prices is also progressively fading away as is evident in the narrowing gap between core CPI and WPI. In such a situation, the manufacturing sector will either increase output prices to protect margins (which will have implications for core inflation) or margins will squeeze until demand picks.
Second, Bharatmala project envisages Rs. 6.92 trillion of infrastructure investment over the next five years. While the target seems to be big and ambitious, the outlay is not much of a jump as compared to the last five years. Ground level implementation of the projects is what will get the growth wheels going. In the past, actual road construction has lagged behind the target and highway projects have been completed in bits and pieces. Whether the private sector investment in infrastructure will crowd-in with Bharatmala, is also uncertain. Most of the infrastructure projects are stuck on account of various clearances and land acquisition. Unless these issues are solved, new projects are likely to turn into new NPAs for the banks.
India’s growth numbers will continue to puzzle economists in the coming quarters.
