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The June quarter’s data for gross domestic product (GDP) numbers confirm the widely held view that despite several government initiatives to push the investment cycle, a broadbased pick up in investment activity is not in sight. With government consumption expenditure likely to moderate in the coming quarters, it raises a question as to whether household consumption alone can shoulder the burden of driving growth.
In the first quarter of the current financial year, gross fixed capital formation, connoting investment in the economy, contracted for a second straight quarter, by 3.1 per cent. It had contracted by 1.9 per cent in the fourth (and final) quarter of the previous financial year.
In large part, this decline reflects lacklustre private investments. CMIE data shows the government’s share of investments under implementation had jumped to a 10-year high of 52 per cent in 2015-16, up from 47.7 per cent in 2006-07, with net addition to projects under implementation by the government rising to Rs 469,100 crore, as opposed to Rs 28,800 crore for the private sector. (MACRO PICTURE)
These numbers affirm the view that higher public sector investment has failed to crowd in private sector investment, as a combination of highly leveraged balance sheets and weak aggregate demand is holding back new investment. The Business Confidence Index of the National Council of Applied Economic Research plunged to 121.6 in April, down from 148.4 in January 2015, indicating that ‘animal spirits’ haven’t revived.
The problem is compounded by global excess capacity in quite a few sectors, steel, for instance. “With global growth continuing to be subdued, capacity utilisation rates are low across the world. In such an environment, it is difficult to see a full-fledged revival in the investment cycle, unless global growth picks up,” says Frederico Gil Sander, senior country economist, World Bank.
In the absence of a revival in investment, economists expect domestic demand to shore up growth in the short term. “In the immediate term, Indian economic growth is likely to be consumption-driven, as a broadbased pick-up in investment activity is yet to set in,” says Aditi Nayar, senior economist at ratings agency ICRA. Sander concurs: “With private investment continuing to be sluggish, in the short term, consumption will drive growth.”
In the first quarter of the current financial year, growth was driven largely by government consumption expenditure, which grew at a staggering 18 per cent. Private consumption grew 6.7 per cent, marginally lower than 6.9 per cent in the previous quarter.
The worry is that government consumption is unlikely to grow at this pace on a sustained basis. Instead, it “might see some moderation, as the first quarter growth was enlarged by the front-loaded expenditure on account of food subsidies,” says Nayar.
Recent data show total government spending contracted by 14.8 per cent in July, with spending down on both the revenue and capital accounts. This suggests government consumption expenditure is unlikely to prop demand, in the absence of which, the burden of shouldering growth is largely on household demand.
Economists do expect the latter to ratchet up towards the end of the second quarter, for two reasons. First, rural demand is likely to see an uptick after two subdued years, as a good monsoon season will push up agricultural production and, as a consequence, boost farm income. This will provide the needed fillip to rural demand. “A good monsoon will increase purchase of tractors, fast-moving consumer goods and two-wheelers,” says Pronab Sen, former chairman, National Statistical Commission. The other impetus is likely via the Seventh Pay Commission report’s implementation.
But some are sceptical at the magnitude of the impact these will have on household demand. According to Madan Sabnavis, chief economist at CARE, “We are overstating the consumption boom.”
While the proceeds of the pay commission add to roughly Rs 1 lakh crore, Rs 50,000 crore is likely to be spent, says Sabnavis. The balance will either be saved or returned to the government as taxes. Further, at the most, the incremental boost to rural incomes on account of a good monsoon season is likely to be in the range of Rs 15,000-20,000 crore, estimates Sabnavis. Add the uncertainty of whether farmers will consider this increase in income as a windfall gain and restrict consumption to consumer durables or consider this a permanent increase in their incomes and raise their consumption across both consumer durables and non-durables. A pick-up in the latter would signal a more lasting pick-up in rural demand. This suggests that there is considerable ambiguity over whether consumption alone can drive growth on a sustained basis.
While the extent of the consumption spurt is debatable, going by past trends, this increase in income is likely to be spent on consumer durables, automobiles and, perhaps, housing. Economists expect this spurt in consumption to raise industry capacity utilisation rates in consumption-oriented sectors, currently in the low 70s. This could spur fresh investment. “It’s only when capacity utilisation reaches 80-85 per cent that we will see a pick-up in investments,” says Sabnavis. “Private investment could see some pick-up towards the end of the year, led by consumption-oriented sectors,” says Nayar.
The first signs of whether this demand-driven investment revival is taking shape will be seen through higher volume growth in the consumer durables and non-durables segment in the Index of Industrial Production (IIP). “Private investments will pick up in consumer durable segments. The uptick in volumes here will be seen through IIP,” says Sabnavis. The hope is that this will lead to increase in demand for inputs such as steel, which could lead to a gradual pick-up in investments over the next financial year.
| OPINION DIVIDED ON RATE CUT |
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While the outgoing governor of the Reserve Bank of India (RBI) has cautioned against lowering of interest rates, is there a case to be made for cutting these, to boost growth in the current environment? Under the new inflation targeting framework adopted by RBI, retail inflation must trend around four per cent, plus or minus two per cent. The Consumer Price Index rise in July was 6.07 per cent, leaving very little room for RBI to lower rates. But, economists expect inflation to trend lower in the coming months, largely on the back of easing of food supplies. Food inflation at the retail level, 8.35 per cent in July, is expected to come down sharply over the coming months as the new harvest hits the markets. |
There are many who believe that given the weak monetary transmission mechanism, RBI needs to aggressively cut interest rates to boost investment. This view takes into account that inflation will trend lower and that the foremost concern is to revive investment.
On the other side are those who believe in an economy constrained by demand, lower interest rates might not lift investment. “While lower interest rates will lower corporate interest costs and boost corporate profitability, they might not be enough to revive investment,” says Sabnavis.
The new governor of RBI, Urjit Patel, clearly faces a tricky situation. Though many believe Patel will stay on the course pursued by Rajan, especially as he’d himself chaired the report on inflation targeting, Deutsche Bank says: “There is little basis to guess the path of monetary policy to be pursued by the RBI under Patel, but there is sufficient empirical evidence to underscore the desirable path. There may be a small window to ease policy in near term, but it would have to be utilised carefully so as not to undermine expectation about inflation and exchange rate stability.”
