Impact of rate tightening to be felt this quarter: Gokarn

Subir Gokarn, director, Brookings institution, and former Deputy Governor of the RBI, expects the full impact of interest rate tightening, effective monetary tightening that was done in order to deal with exchange rate pressures, to felt in this quarter.

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In an interview to CNBC-TV18, he said though India received above normal monsoon which will be a big boost to agriculture, but slowing manufacturing may offset gains arising out of the expected good harvest.
The economic growth or GDP in the first quarter of the current year grew by just 4.4 percent compared to 5.4 percent in the year-ago period and 4.8 percent in the previous quarter, January-March of 2013. In fact, 4.4 percent is the slowest in 16 quarters or 4 years. The last time the country witnessed such slow growth was in the quarter after the Lehman crisis.
Services as a whole grew by 6.6 percent, but within services, a category called trade, hotels, transport and communication, which comprises small shops, restaurants and riskshawalas grew by just 3.9 percent. Gokarn says, the employment scene for a lot of low-income, low-skill people is going to be tough. Labourers involved within the category of trade, hotels and transports will be impacted, he adds.
Mining contracted by 2.8 percent. Manufacturing contracted by 1.2 percent. Barring agriculture, which grew by 2.7 percent thanks to a decent rabi harvest, everything else is slowing in the economy.
A category called community, social and personal services grew by 9.4 percent but that's largely sectors like hospitals, education etc. which are dependent on government expenditure.
Looking at GDP from the expenditure side, personal consumption expenditure grew by just 1.6 percent, while capital formation contracted by 1.2 percent indicating that both the investment and consumption cycle are weak, very weak. Below is the verbatim transcript of Subir Gokarn's interview on CNBC-TV18 Q: What is your sense of the trajectory of GDP? At 4.4 percent do you think we have hit the bottom or do you think worse is to come?
A: I think as you have said that this quarter will have the full impact of interest rate tightening, the effective monetary tightening that was done in order to deal with exchange rate pressures. Given that in the last quarter for example credit growth was around 13.7 percent as per the press release, that number is likely to go down, because this situation suggests a further credit squeeze.
So it is quite likely that at least on the interest sensitive part of the economy which is essentially manufacturing and some component of services, construction for example that you might see a further decline. On the other hand we have an above normal monsoon across the country, a few deficiencies but for the country as a whole it is a good monsoon. So there will be some boost in agriculture. So the two might actually offset each other and that is really the expectation overall.
So I do not know if the number is going to be very much different, but what is important is the composition of growth to the extent that we are seeing negative growth in manufacturing and the slowest growing sector is mining.
When we talk about the Current Account Deficit (CAD), minerals are playing such an important role in the way CAD is shaping up that if mining is showing this tendency that is simply suggesting more and more pressure from that front. That has got to be the priority for the government in terms of addressing the CAD. Q: Trade, hotels and transports have come in at a measly 3.9 percent. That is almost half the services sector and a good 25 percent of the overall GDP. If that were to slowdown what are the repercussions for future? Any extrapolation as to whether it takes a very long time to crank this up?
A: I think this is the component of services that is most directly tied in with the others. This is very employment intensive, because trade includes pretty much everything from the panwala to the Marks & Spencer. So a lot of people are involved. A lot of low-income, low-skill people are involved here. We are looking at even without being able to quantify it the employment implications of this pattern trade, transport are both very, very employment intensive, this would suggest that there is stress on this stratum, this level of households.
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So it is important to now look at is as a flow through, as a spill over of a slowdown in activity, manufacturing minus 1.2 percent, mining minus 2.8 percent related because minerals feeding to manufacturing and construction 2.8 percent, so obviously there is potentially a loss of employment in the construction sector as well. All this is feeding into reduced demand for the kind of services that this big omnibus trade, transport, hotels and restaurants provide. Q: If you looked at GDP from the demand side then actually capital formation has contracted by 1.2 percent. What policy options does the government have to reverse this terrible cycle?
A: We see the gross fixed capital formation (GFCF) in real terms at 32.6 percent of GDP. The incremental capital output ratio (ICOR) is a very, very crude rule of thumb parameter. Typically you expect it to be between 4 and 5, so if you are investing 30 percent you should be getting around 6.5-7 percent growth. We are investing 32.6 percent and we are getting 4.4 percent growth which tells us that our capital stock is being used extremely inefficiently. We are under-utilising capital. These are all bottom up elements that add up to this rather striking decline in the efficiency of the use of capital. Q: If capital formation is contracting by 1.2 percent and if ICOR has jumped to beyond 5 percent to probably 6 percent or more then what should be the government's policy priorities?
A: I think from the capital utilisation viewpoint it all adds up to one basic conclusion that the forces that are driving the slowdown and the forces that are driving the widening CAD are essentially the same and I would attribute that to basically our loss of ability to produce minerals. Coal is creating a problem. We are importing USD 8 billion plus worth of non-coking coal a year. We are importing more non-coking coal than coking coal now. That is adding to the Balance of Payments (BoP) pressure and that is obviously increasing the cost of production of power. Power generation is impacted by that.
So basically restoring the balance in the capital stock that is bringing or leveraging off the complementaries is very important. We need to get the capital ICOR down back to about 5 or 4 percent which means that for 32 percent investment we should be at least getting 6-6.5 percent growth. Q: If we are able to ensure that this mining ban is negotiated and removed and we restart mining at our normal capacity and that includes of course even gas extraction because gas also is included in mining do you think that would be the first and the most important step and not interest rates to really get back?
A: Keep in mind that if we are to look at the monetary policy role here we typically say that monetary policy has a two or three quarter lag on growth. Monetary policy was being eased from April 2012 till May 2013. If you take the normal lags into account the impact of monetary policy on growth in this quarter should have been at worse neutral or positive. So you cannot attribute this to monetary policy.
What you are seeing here is essentially the playing out of supply-side constraints and that is showing up very clearly in the growth numbers of the various components of the production side. So we can zero in on priority as far as policy is concerned and that is breaking through the minerals. I have been arguing for a long time on this channel and others that the straw that broke the camel's back in the last two years was the mineral complex and that is showing up very clearly in these numbers for this quarter. Q: Do you think rating agencies are going to pronounce a negative verdict, a downgrade before we are able to set the house in order?
A: That risk has certainly increased over the last few weeks. It was quite vivid towards the end of 2012, but it abated because certain measures were taken, particularly we have started to address the fuel subsidy issue at least tangibly if not dramatically. I think the same pressures now have mounted, because if you look at under-recoveries on diesel they have probably exceeded the highs that we had in September last year. So that risk is there. It is something that we just cannot ignore and what that calls for is to intensify the process of correction on the subsidies.
Also going back to the earlier discussion, how do we get the iron ore mines back in operation, how do we get more coal out of the ground and these are the two questions which are of critical importance now. I have not seen adequate answers. We know that it has to be done. The objective is very clear, but the how is not yet with us and that is what we need to focus on.