Talking Point: Why GDP growth will only be moderate

In May 2014, when the NDA Government took over , the business sentiment swung from despair to hope. Stock markets, first in anticipation and then in jubilation, soared to record highs. The NCAER’s Business Confidence Index, which had declined to 100.4 in October 2013, reached 143.5 in July 2014. The mood was so euphoric that a V-shaped economic recovery was considered to be the inevitable outcome. One-and-a-half years later, recovery is nowhere in sight.

It is our view that given the global and domestic macroeconomic conditions, a V-shaped recovery was neither possible nor desirable. On the contrary, what India needs is not a rapid GDP growth but a non-inflationary one. That is, the actual rate of GDP growth should be close to the potential rate. And this depends on the supply and productivity of capital and labour.

GDP growth, after bottoming out in FY13 at 5.1 per cent, has been close to the potential rate of growth so far and could sustain this trajectory.

This, however, has not gone down well with business sentiment and capital markets. While the NCAER’s Business Confidence Index, after peaking at 148.4 in January 2015, fell to 126.4 in July 2015, the BSE Sensex at 26,121 on November 9, 2015, is much lower than the closing peak of 29,682 it attained on January 29, 2015.

On the domestic front, macro economic fundamentals look much better now than in mid-2013. Now, inflation is low, rupee is stable and fiscal and current account deficits are no longer a threat. Still, there are some cyclical challenges that could wane with time and a number of structural issues that would require concerted efforts from the government and the private sector.

On the global front, recovery appears to be losing steam. The International Monetary Fund (IMF) revised its global growth forecast for 2015 to 3.1 per cent from 3.3 per cent. Global growth remained weaker than expected in the first half of fiscal 2015 due to a slowdown in emerging markets and a slower recovery in advanced economies. While a slight pick-up in GDP growth is expected in advanced economies, emerging markets and developing economies are projected to decline in 2016 due to falling commodity prices, weakening currencies and increasing financial market volatility.

Another key risk for India is the collapse of global trade volumes. They are under a serious threat due to weak investment climate and trade spillover of China’s growth transition. The World Trade Organization has revised its global trade growth forecast for 2015 to 2.8 per cent from 3.3 per cent — the fourth consecutive year of sub-3 per cent growth. It is also the fourth year when trade has grown lower than world GDP.

India’s merchandise exports have contracted 17.7 per cent for the April-September period in FY16.

Still, a number of factors are making us more hopeful about an incipient economic recovery. The Index of Industrial Production (IIP) grew 4.1 per cent over April-August FY16 as against 3 per cent during the same period in FY15. Use-based classification of IIP data shows that unlike in FY15, all use-based segments are showing growth for April-August FY16. Capital goods and consumer durables sectors declined 10 times and 20 times respectively during the last 24 months.

But as per August 2015 data, the capital goods sector clocked back-to-back double-digit monthly growth for the first time since December 2010; consumer durables witnessed three months of consecutive double-digit growth for the first time since March 2011. Even some of the services sector indicators, such as tourist arrivals and railway freight traffic, show signs of revival.

With two consecutive sub-par monsoons, although rural demand is expected to remain somewhat tepid, it is unlikely to collapse as more than two-thirds of the rural income is now non-agricultural income. Therefore, net-net the GDP growth in FY16 at 7.5 per cent will only be marginally better than in FY15.

The writer is Principal Economist and Director - Public Finance, India Ratings & Research. With inputs from Devendra Pant and Apurva Yadav,India Ratings & Research.