To recapitulate, the adverse impact of demonetisation and GST on growth is relatively modest and temporary. As noted at the outset, the steady decline in quarterly growth started long before these shocks hit the economy. What then accounts for the slide in growth?

The answer will be evident from the adjoining table, which shows how different components of aggregate demand in the economy have behaved in the last five quarters. Growth today is rather like the flight of a six-engine plane where one engine is going full throttle while the other five are slowing or shutting down. The engine propping up growth is government final consumption expenditure. It grew by 17.2 per cent in Q1 2017-18, which is higher compared to growth in Q1 2016-17. All the other positive components of demand have been slowing down while the negative components have grown dramatically.

The largest component is private final consumption expenditure, accounting for more than half of GDP. It grew by 6.7 per cent in Q1 2017-18, which is not low but much lower than the 8.4 per cent growth recorded in Q1 2016-17 (see table). In advanced countries, consumption is driven by income and wealth effects. In a low middle-income country like India, consumption demand is mainly dependent on income. Hence, the slowdown in consumption growth is a reflection of sliding GDP growth rather than its autonomous determinant.

The two main autonomous drivers of demand growth, apart from government consumption expenditure, are fixed investment or gross fixed capital formation (GFCF), and the balance of trade. Of these, GFCF declined quite sharply to only 1.6 per cent in Q1 2017-18, down from 7.4 per cent in Q1 2016-17 (see table). The slippage appears even more sharply in the index of industrial production data, which shows that production of capital goods actually declined by 3.9 per cent in Q1 2017-18. The decline in June was by as much as 6.8 per cent. This decline reflects the sharp slowdown in private investment.

This particularly worrying trend has persisted since the investment rate peaked at over 34 per cent in 2011-12. By 2016-17, it had come down to 29.3 per cent. Private investment, which accounts for the bulk of investment, came down from 27 per cent in 2016-17 to only 21.9 per cent in 2016-17. The decline has continued in 2017-18. Despite the pump-priming efforts of the government, attempts to reduce infrastructure bottlenecks and improve the ease of doing business, nothing seems to be working. Many Indian entrepreneurs are reported to be increasingly investing abroad rather than in the country.

Saying that investment is an autonomous driver of growth was an oversimplification. Private fixed investment depends very much on recent trends and prevailing business conditions. These include the logistics and power constraints, the difficulty of doing business and the failure to come to grips with non-performing loans (NPL), especially in public sector banks, which has shrunk the flow of credit. Only irrational exuberance can lead us to believe that the private investment cycle will revive without a significant turnaround in these conditions.

The other major autonomous source of demand is the external trade balance. In India’s case, this is a leakage of demand to the rest of the world, a negative component, since India runs a trade deficit. This negative trade balance has gone up by an alarming 295 per cent in Q1 2017-18 compared to Q1 2016-17 (see table). This is a massive negative shock to the economy, arising from the slowdown in export growth while imports have grown by over 13 per cent in real terms. The sharp rise in imports has occurred despite prices of commodities, especially oil, remaining subdued. On the export side, weak global demand is no doubt a part of the problem. But other competing countries have done better and raised their share of global exports while India’s share has declined.

This sharp deterioration of the trade balance is primarily attributable to appreciation of the exchange rate, which has made imports cheaper and exports more expensive in relative terms. Annual fluctuations apart, the 36-country trade weighted real effective exchange rate (REER) compiled by the RBI has seen a rising trend for several years. It is about 18 per cent higher now compared to 2006-07. The appreciation has been particularly marked since January this year. Hence the sharp rise in the trade deficit.

Two remaining elements of aggregate demand require brief remarks. I have commented on the slowdown in stock growth, clearly an impact of GST-related uncertainties. The other component is valuables, which presumably includes gold, jewellery, paintings, antiques and other such exotic items. This component, which has grown by about 200 per cent in Q1 2017-18 compared to Q1 2016-17, is a diversion of demand from current streams of production.

Given this depressing picture of demand, what is surprising is not that GDP growth has declined in Q1 2017-18 but that it has not declined further. The key question is, what can the government realistically do to turn around this dismal trend?

It is quite easy to set out a long menu of all that needs to be done. But two points need to be kept in mind. One is state capacity. As is evident to every citizen, there are limits to what the state, in particular, the executive branch, can deliver. Overloading the government with too many goals, policies and programmes simply leads to a growing gap between the goals on paper and achievements on the ground.

The other point is that the government is now well into the fourth year of its term. The final year leading up to the 2019 election can be written off for policy or reform purposes since the government will be in election mode. Politically popular measures will get priority over all else. In other words, there is only a very narrow window, if that, to attend to any serious policy measures.

Given that context, it may be best for the central government, and the RBI, to focus on just a couple of key measures that are implementable and could have a quick positive effect. The first is to control and turn around the appreciation of the exchange rate, something that the RBI could easily accomplish in cooperation with the government. The several available options to do this are well known. The second move would be to finally bite the bullet on the NPL problem of public sector banks. The bankruptcy code and other related developments have set the stage for this to be done. What is required is the will of the political leadership to get it done.

These two moves alone could bring about a sea change in the business environment and the outlook for economic growth. That in turn would provide the space to attend to other reform measures in a more calibrated manner over the medium to long term to place the country on a sustainable and employment-intensive high-growth path.

(Mint)

Sudipto Mundle

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