Is economy seeing signs of constant growth? Experts analyse

Financial services grew well at 10.4 percent but that remains an enigma. For the past many quarters, finance has been growing at near 10 percent while the real economy grows at half this pace.

Looking at GDP from the demand side, private consumption grew by 5.6 percent in the April-June quarter, not very different from last year. But the good news is that gross fixed capital formation has grown by 7 percent, much better than the contraction of 2.9 percent last year same quarter.

A panel consisting V Srinivasan, Executive Director -Corporate Banking at Axis Bank, Dr. Arvind Virmani, Former Chief Economic Advisor and Currently Advisor to the Reserve Bank of India (RBI) and Sajjid Chinoy, the Chief India Economist at JPMorgan discuss if India is on the path of persistent growth.

Below is the edited transcript of the discussion:

Q: What is the sense you are getting? This is the best number in nine quarters, manufacturing, a sector you will be servicing, has grown at 3.5 percent not good in itself but best in 10 quarters, are you getting signs that things are ticking?

Srinivasan: That is the enigma; the GDP number i.e. clearly the headline number has come much higher than what we have seen in the past largely to some extent, driven by index of industrial production (IIP) and manufacturing. If you look at bank credit as such, bank credit has been slower than what it was last year. The puzzle is growth seems to be coming back or at least showing signs of coming back but if you look at the actual activity on the ground or what banks are seeing in terms of overall system growth of credit, it seems very lower than what it was last year.

Q: Have you had this experience in the 2003 period when again the economy showed that traction from five years of slowing to picking up speed, usually at this time is it that corporates normally manage their cash better?

Srinivasan: Yes, there should be some amount of operating leverage as things have been slower and as things start coming back, operating leverage is something which corproates would have and therefore you could have a period by which credit demand can be slow even though activity level sort of perk up.

But even in terms of pick up, in terms of working capital and related activities, I would still think activity on the ground has not shown the sort of trend which this number is showing. So we need to watch it for a few more at least the next quarter before we jump to a conclusion of whether it is sustainable because as you said whether it is agriculture or whether it is IIP, I think we are - one is on account of rabi in terms of overflowing to Q1 and also on industrial growth we are coming from a low base. So the numbers are good, the numbers at least give some room to cheer but whether we can say, we have crossed the hump, I think we need to watch it for at least another quarter.

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Q: Your key takeaways from the numbers?

Chinoy: I think it is a good news bad news story. First let me tell what some of the sobering part is. If you look carefully at the details in the production side, a lot of the growth between last quarter and this quarter has been driven by government spending. Community services grew at 3 percent last quarter 3.3, they have grown at 9 percent this quarter. So that clearly is not sustainable going forward given that the government has got to slam on the expenditure break at some point to reach fiscal deficit target. So that is one factor which will not sustain.

Another factor that will not sustain is agricultural growth. You have seen 3.8 percent, it is a rabi effect. Going forward, we will do very well if we get 1 percent growth for the rest of the year. So both of these key drivers will not sustain.

If you look at actual business cycle dynamics, you take away agriculture and take away community services, the picture isn’t that pretty on a quarterly sequential annualized momentum basis. It has fallen from 4.5 to 3.5 percent largely because services growth has decelerated. So at some level, the headline number maybe good, the details are much less solid and maybe not as sustainable.

Q: What if I were to look at it this way, ultimately the government contribution is about Rs 2 lakh crore and agriculture also is Rs 2 lakh crore, together they are only contributing, say, electricity again at Rs 2 lakh crore, the contribution of these two sectors is exactly what would be a combination of manufacturing plus maybe construction and those two have shown some traction compared to previous quarters. So in the quarters to come what these two will not give could be given by manufacturing isn't it, manufacturing is the best in ten quarters and that is a fairly decent Rs 2 to 2.5 lakh crore about 20 percent of the economy?

Chinoy: Correct, so I am not disputing, I am just saying that in our forecast for this year somewhere but 5.5 percent, a lot of people would look at 5.7 percent, oh this does not even reflect the actions of the new government. Maybe the growth will end up at over 6-6.5 this year. I am simply saying that there will be some offsets to growth, agriculture will slow, community services will slow, as you rightly pointed out hopefully export momentum continues and you get some pick up in the other sectors, so we end up with 5.5.

The good news here is if you look at the breakdown of where this growth is coming from the expenditure side. With the caveat that the quarterly expenditure numbers are very unreliable and often revised, the fact that gross fixed capital formation has picked up and consumption growth both sequentially and year-on-year has come down very sharply is very good news. I would much rather end the year with lower GDP growth on the whole but a much greater focus on that growth coming from the supply side, coming from fixed capital formation and coming less from consumption. So that for me is the key highlight from today’s number more than 5.7 percent number.

Q: Dr Virmani, your first takeaway from the numbers?

Virmani: Firstly, when you look at the numbers, they are base effect. So you have to do the seasonally adjusted numbers as has been implied by both the earlier speakers. Having said that, I would say three things, one is in December-January when I put out an agenda for the new government; I had suggested that if they do these things, we would get one percent increase in growth that would be like 5.6 or 5.7 percent. I still expect that to happen.

We can go into the agenda but let me just finish the two other points which I noted - one we had seen from the IIP that the manufacturing growth is unprecedented, we have been at the kind of bottom for 8-10 quarters, which I haven’t seen for a long time. So this shows and kind of confirms that the recovery in manufacturing is underway.

The third point which I had noticed in the IIP was the capital goods picking up. Now again, we have the base effect, there was a big decline earlier last year but if the seasonally adjusted numbers confirm that - that would be my third takeaway that the recovery of capital goods would be good news. So given all these things, I would say that I am now confident of my forecast and I would say there is a probability of an upside. So it would be higher than what I have been saying.

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Q: Capital formation as Dr Arvind Virmani and Sajjid Chinoy pointed out is showing a 7 percent growth for the first time in many quarters, it was contracting. Is it possible that the first dose of growth companies normally manage on their own and therefore should we clutch at this as a straw or do you think that you will not celebrate just yet?

Srinivasan: I am not saying that what we are seeing in terms of headline number or in terms of IIP growth or manufacturing is not happening. I am just saying that the activity levels, which one would generally associate with banking sector activity as a corollary to this is something, which we are yet to see. Hopefully, that is going to come through over the next quarter or two, which is when this becomes sustainable.

The operating leverage possibly in terms of whatever people have not invested the accruals they have, the better balance sheet structure with some other corporates may have may result in some of these gross capital formation being better and to some extent it can be driven by public sector undertaking who have huge cash surpluses. So I think the good news is there, the banking sector activity needs to pick up and I am talking not just of clutch of banks, if you look at the systemic growth in terms of credit growth, we are at 12 percent compared to possibly around 15 percent last year.

Even if you take year-to-date growth, it is much weaker than last year and it is driven by agricultural growth. So the thing is that if agriculture to some extent falls off and banking sector growth is possibly much weaker than what the headline number suggests, that is what I want to keep in mind when I say that how sustainable is this.

Q: What is your ground level feeling with respect to exporters? Exports have been a very big contributor as both our other guests also pointed out, 11.5 percent, are export is coming to you for more money?

Srinivasan: Exports is good news but again one needs to look at the currency move last year. You saw a sharp currency move last year on the back of which our exports are growing but as you go through the year, the level of currency which propped up export growth, to some extent that thing is not going to be there on a year-on-year basis. The currency push is going to be a little less and therefore, it is going to be on the back of strong productivity gains and expansion to new markets and that is why the test of this 10 percent growth is going to come from. I believe that export growth is going to be stronger but whether it sustains at this level is something that we need to see as we go forward.

Q: There are couple of areas of scepticism that Sajjid Chinoy and V Srinivasan are pointing to. One that agriculture definitely is going to let us down in the coming quarters, we know that the monsoon is sub-par. Secondly, we may not get this kind of a stretch from exports, the base effect will catch up. After all, 60 per dollar has been the order of the day for the past twelve months and we are now getting recessionary news from Europe as well and of course government expenditure that big growth of 9 percent is unsustainable, so do you think there are some dangers to 5.7 being sustained?

Virmani: The two points raised earlier firstly on the capital, the borrowing for capital investment. At this cyclical point when you have a recovery in profits, you will base investment on reinvestment of profit. So I am not worried about that as much as the gentleman from banking.

Secondly, the issue of non-performing assets (NPAs) and recapitalization of public sector banks, that is definitely on my policy agenda, it has to be addressed, we have forgotten about it in the first three months or 100 days whatever because some of the other things, which needed to be done have been done. I can mention the restoration of confidence, the gridlock in government has been eased and so on. But we need to get this part of it done too.

The third point on exports, I think, definitely the US market is recovering. Europe as predicted - in fact, in my farewell speech to the IMF in 2012, I said that I would expect a lost decade in Europe. That is certainly coming about because of the policies that they instituted, again in my view wrong policies. As far as the US is concerned, there is a slow and steady recovery. So, I am not that worried about exports. I think they will pick up gradually but no dramatic change.

So the question is what is your benchmark? When you say, is there danger to 5.7 percent, those people who are predicting less than 5.7 percent is the issue. I have always predicted about 5.7 percent. So I don’t think there is a danger to that for the year as a whole. That doesn’t mean that the next quarter will be 6 and the quarter after that will be 6.5 percent and then 7 percent, of course not. That is not something one expected. Therefore, I am very confident now that we will get an average 5.7 percent, I would not be able to say next quarter because I haven’t looked at all the numbers yet but I am very confident that we will get the average.

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Q: Now to the immediate problem at hand, the coal issue. Is this likely to cream away some of the growth in power sector which has grown by a good 10.2 percent, as well as a lot of downstream activity and the sheer uncertainty that it continues to colour all economic activity with, is there a fairly severe danger looming?

Chinoy: It all depends on how this venture resolved. The good news is that if you look at captive coal production that is only 10 percent of total coal production but I think the impact on power production on having to import coal, on investor confidence more generally, on having more retrospective changes to policy 15 years after policy was made can never be good for confidence but it all depends on where the SC finally comes out. There are middle of the roads solutions, which don’t necessarily have to affect both growth or the current account dramatically.

Q: Would you worry about export growth?

Chinoy: I don’t. we have done a lot of work just to show that India’s exports are far more sensitive to demand impulses from global growth impulses.

Q: That is why the recession in Europe, will that hurt?

Chinoy: Think about what happened in the last 48 hours, US Q2 growth has been moved up to 4.2 percent albeit some of these inventories. Our forecast for US growth in the next three-four quarters is still 3 percent. Europe is still supposed to grow faster in the second half than in the first half. China will slow slightly but if you add up all the numbers and do an add-up exercise, it is JP Morgan’s global growth forecast in the next three quarters is significantly higher than the last two quarters to the extent that the pie is becoming bigger and global demand is accelerating. Even if the fact that the normal exchange rate is not depreciating, I am quite hopeful about exports being a driver of growth. If you look at new export orders in the PMI, they have been increasing steadily over the last four-five months. There are very good leading indicators of exports. In fact, ironically, the year may end where most of the growth pick up is driven by external factors more than domestic factors for this particular fiscal year.

Q: If God forbid, there is any rate hike in January because we are not able to keep inflation on the track, it may not happen at all but will that spoil the picture?

Srinivasan: I don’t think so. I believe that is extremely low probability.

Q: If they were stable, that is not going to spoil the picture?

Srinivasan: That is not going to spoil the picture. We have lived around these levels if you looked at the base rates of banks, which is primarily the indicator at which corporates - that is a benchmark, which corporates are more sensitive to, it is around 10-10.25 percent and that has been there for almost last 4-6 quarters. The range is not changed at all. So, I don’t think that is going to be having any bearing in terms of how exactly the economy performs.

I think it is important for us to sort of look at as you said the policy related issues as well as in terms of the banking sector issues, in terms of some of the other things which are going on. I think those will have a much larger impact in terms of how exactly things move forward.

Q: 7 percent gross capital formation, can that extrapolate into something dramatic and make your numbers look a little moderate?

Chinoy: Yes and to extend this, it reflects the activities of both the previous governments and last governments. Last four quarters you have seen a cabinet committee on investment, you have seen both governments chipping away at this. I think that is the most important thing. If we can get the supply side moving again however modestly, it bodes very well for sustainable growth. What you don’t want is growth accelerating to 6-6.5 percent driven by demand and consumption, that strokes inflation that widens the current account deficit and is not sustainable. For me, the best news is that that is going at 7 percent and the fact is this government has shown real seriousness on the supply side through small steps over the last three months, if that continues, this will show up in FY16 growth more definitively.

Q: What is your estimate for next year’s growth? You said you are expecting 5.7 percent in FY15?

Virmani: Yes. A number of hints have been given in the Budget, the expenditure commission etc so there are whole bunch of things which have not been done but which are in process. If all those are done that I would expect again another percent point increase. So up to more than 6.6-6.7 would not surprise me if those things are implemented.