Deepening economic stress

Latest data suggests no respite from bad news

The slowdown in the Indian economy is deepening. The data suggests that growth in the July-September quarter might have slipped below the six-year low of 5 per cent, recorded in the April-June quarter. Output in the core sector fell by a massive 5.2 per cent in September, its sharpest decline in at least a decade with seven of the eight industries comprising it witnessing contraction. The core sector has about 40 per cent weight in the index of industrial production (IIP). A sharp contraction in core-sector output will put further pressure on overall industrial production. The IIP declined by 1.1 per cent in August.

 
Further, the purchasing managers’ index showed that growth in manufacturing fell to a two-year low in October. The collection of goods and services tax was once again below the Rs 1-trillion mark in October. The Central government’s fiscal deficit reached 92.6 per cent of the full-year target in the first six months of the fiscal year, owing to slower than expected growth in revenue collection as tax mop-up in the fiscal year could fall short by Rs 2 trillion. The silver lining perhaps is the mild uptick in sales of passenger vehicles. Maruti Suzuki India, for instance, showed growth in sales after eight months in October. However, it could just be reflecting the festive demand and might not sustain in the coming months. Commercial vehicle sales, for instance, continue to contract.

 
It is possible that the second half of the fiscal year could look comparatively good purely because of the base effect, but the extent of the slowdown is deeply worrying. The stress in the financial system, the inefficient transmission of monetary policy, and the state of the government finances would limit the possibility of a turnaround in the short run. While the Reserve Bank of India has reduced policy rates by 135 basis points this year, transmission has been poor. However, the bigger worry at this stage is the state of the government finances. Lower than expected economic growth will directly affect revenue collection and push up the fiscal deficit. But a sharp cut in expenditure would accentuate the slowdown. Additionally, questions have been raised about the quality of the Budget data, including by the Comptroller and Auditor General of India, and the government would be expected to improve transparency and address the issue of off-Budget liabilities. It will not be easy for the government to strike the right balance.

 

To be sure, there are limits to what the government can do in the immediate short run to lift economic growth. However, India would need policy reforms to return to a higher growth path in the medium term. The government should work in a holistic manner with the clear objective of increasing potential growth. For instance, it has done well by reducing corporate taxes, but more would be required in terms of factor market reforms to attract investment. India is considering being part of the Regional Comprehensive Economic Partnership, but it needs to swiftly prepare to maximise gains from trade in the medium term.

 
Evidently, the slowdown is much deeper than what most people expected, and a sustainable recovery would need interventions going beyond another rate cut or allowing some fiscal slippage.