Is sub 5% GDP growth new reality? Experts discuss

Samiran Chakrabarty of Standard Chartered Bank expects second quarter GDP growth a bit lower than the first quarter and in the range of 4-4.4 percent due to rupee depreciation and higher interest rates hitting the market.

The gross domestic product (GDP) for the first quarter came in at 4.4 percent and the July fiscal deficit numbers which showed that in four months the government had reached more than 60 percent of the full year deficit of over Rs 5 lakh crore. Sonal Varma of Nomura also believes that the potential growth of the economy has been declining almost in every sector. “This fall is not only because of the potential in the manufacturing sector, which is linked to investment coming down, but also the affect of slowing industrial activity in services and so, potential growth in services is also coming down because of the impact of manufacturing,” she explained. Discussing about the possibility of a rating downgrade, Chakrabarty said that the next three months will be very crucial and market could see rating action if they do not stabilise. “Not only macros, market will also be equally important in deciding the rating action at this moment,” he told CNBC-TV18’s Latha Vankatesh. Varma is also of the view that the probability of a rating downgrade is increasing. Below is the verbatim transcript of their discussion on CNBC-TV18 Q: The GDP numbers came in at 4.4 percent in the first quarter and so, we don’t appear to have troughed because in the July-September we have the double whammy of the rupee depreciation and higher interest rates hitting us- what is your estimate of second quarter? Chakrabarty: We are definitely basing for a print which is lower than the first quarter, maybe in the range of 4-4.4 percent. What will be critical is how the index of industrial production (IIP) numbers over the next two months come out. If they show significant contraction in industrial activity, there could be downside risk to the number.

_PAGEBREAK_ Q: One ingredient of the GDP which is particularly shocking is trade, hotels, transport and communication that component which is 25 percent of the GDP has fallen to 3.9 percent. With that slowing to 3.9 percent – what is your estimate? Could it take a long while to crank up the economy? Varma: The potential growth anywhere has been declining. We would be arguing from 8 to 7 to 6.5-6 percent and now potential growth estimates would probably be under 6 percent. The fall in potential that we are seeing is not just because of the potential in the manufacturing sector which is linked to investment coming down but also the affect of slowing industrial activity in services and so, potential growth in services is also coming down because of the impact of manufacturing. For sometime we are going to see these low numbers and potentially lower numbers as well. If one has to revive the entire cycle then we need to begin the capex cycle which at this stage looks like it is going to happen only after a few quarters. We are going to have lower growth for some time, the potential growth of the economy has fallen. The estimates may vary from 5.5 to 6.5 percent but that does not mean we won’t have cycles. But the worrying part is that we will now have a cycle around a much lower potential growth and that is what we really need to focus on more from a medium term perspective. Q: Mining has been negative for the last six quarters. Do you think that even if interest rates were kept high to protect the rupee, if the government can get this piece right we can still crank up the economy pretty quickly? Chakrabarty: Natural resources, mining resources are critical components of a country’s growth. About 20 percent of private sector corporate capex goes to metals and mining and so, the number is pretty significant. There are different mining issues we are dealing with now from iron ore, mining ban in the KG D6 basin for gas to Coal India's mining problem so, it is not easy to say that all of these will get resolved at the same time. It is not just growth that can be improved through these measures but also significant part of current account deficit can be addressed. Q: Do you believe this is something that can be done by the government in its remaining tenure? Chakrabarty: I was trying to distinguish between all this just because something like the iron ore mining ban is not under government’s control. It is Supreme Courts decision. Similarly on KG D6 gas issue, now there is some clarity on gas pricing policy but that does not mean that within the next few months this will start producing a lot of gas. Similarly on coal, there are lingering issues, there is progress but it might be painfully slow.

Q: The fiscal deficit number of 4.8 percent is based on revenues coming in and the 4.4 percent is the first quarter GDP and all of you are moving south of 5 percent, maybe 4.7-4.6 percent and full year GDP revenues are going to be impacted. Do you have any initial numbers on the possible tax revenue growth of the country? Varma: Yes. There are multiple sources of this stress on fiscal finances. Firstly, there is the tax revenue growth. The budgeted number is 19 percent and April to July, the net tax revenue growth has been under 2 percent. There is a significant gap between the budgeted and the actual tax receipts and this pressure will continue given the state of the economy. Secondly, pressure is from currency depreciation both on the fuel side as well as on the fertilizer side. Thirdly, the Food Security Bill while it is going to be implemented only for a few months this year nevertheless there will be some additional subsidy burden this year. Fourthly, the disinvestment receipts that the government has budgeted in this market condition looks like a tough task. At the end of the day whether the government is able to meet its 4.8 percent deficit target or not depends on the extent to which they will be willing to actually cut down on spending which is something similar to what they did last year. The government has no option. I don’t think there are any more shortcuts. There maybe an election but given the threat from rating agencies, given the threat on the external sector the government will have no option but to actually cut down its spending.

_PAGEBREAK_ Q: Instead of 19 percent what could be the best revenue collection of the government and even on fuel subsidies can the government come down to zero as it was expecting to do? Chakrabarty: There is a significant slippage possible on the fuel subsidy bill. If oil stays around USD 115 and if rupee stays around 65 then that itself might mean that the oil subsidy bill is closer to Rs 85,000 to Rs 95,000 crore which is much higher than what the government has budgeted. On the revenue side, the four months of data that we have got shows that the revenue is much lower than what the government has budgeted but there could be a silver lining that the service tax growth which is showing only 14 percent against the budgeted 35 percent, there were some misinformation, lack of clarity on the change service tax rules because of which the progress on service tax has been poor. It is possible that in the rest of the year it will be made up by the short fall here. To that extent, there could be some support on the revenue side going forward. People are hoping that like last year the finance minister will be able to cut back substantially on plan expenditure and that could provide some relief at the end of the year. Q: But that could also bring the GDP down much lower in the third and fourth quarters – wouldn’t it? Chakrabarty: Last year as well, it was cut down very substantially. On a year over year basis the decline might not look that bad. Q: Do you think a threat of a rating downgrade is very high? Varma: The probability of one is increasing and particularly of the three S&P is the one we need to watch out for. Chakrabarty: The next three months are going to be very crucial and we could see a rating action within three months if the markets do not stabilise. Not only macros, market will also be equally important in deciding the rating action at this moment.