No changes in stance or rates were expected and the latest monetary policy committee (MPC) meeting did not disappoint. The continuation of the pause and withdrawal of accommodation stance meant that it did not expect inflation to come down any soon. Underlying its inflation forecast of 5.1 percent for 2023-24 were concerns about food prices especially, given the uncertainties around the monsoon. But on growth it seemed more sanguine, reiterating its forecast of 6.5 percent GDP growth for 2023-24 even as others downgraded their numbers. But where does the RBI’s optimism come from? There seem to be two sets of reasons, one relating to the year gone by and the other to the current year. The first relates to the higher-than-expected real GDP growth of 7.2 percent in 2022-23 while the second was about the buoyancy in consumer demand and the revival of investment activity in the current year. Both are worth examining.
Narrowing Trade Deficit
The extra 0.2 percent growth for 2022-23 has been a mystery of sorts. It has been explained as caused by a late growth spurt (6.1 percent) in the fourth quarter coming from manufacturing (4.5 percent), exports (11.9 percent) and investment (8.9 percent). But the answer perhaps lies in the revisions to numbers between the February 2023 (second advance estimates) and May 2023 (provisional estimates) releases. The major revision was in the trade deficit, which came down by a significant 28 percent. Also worth noting is that this came on top of a 58 percent decline over the January 2003 number (first advance estimates). Given trade deficit’s inverse relationship with GDP, this reduction in May added about 0.9 percent to GDP growth, which was more than consumption or investment. Quarterly numbers and data revisions have always been problematic with the World Bank even remarking that final numbers were sometimes different from initial estimates by as much as 0.5 percentage points. Variations in trade deficits matter a lot, for the simple reason they are subtracted from GDP.
The CEA has hinted that the final growth rate for 2022-23 could even be higher when the numbers are ultimately finalised in 2026. But the point is really about the key role of oil prices and trade deficits. They are a double-edged sword — cheaper oil from Russia during the latter part of 2022-23 helped bring down import bills and the deficit. It has happened in the past too (2013-14 to 2016-17) when low oil prices lifted GDP growth. But if oil prices were to rise again, rising trade deficits could adversely impact growth.
Boost From Consumption
The other set of factors that makes RBI optimistic about growth are the buoyancy in consumer demand and the revival of investment. Increased passenger vehicle sales, domestic air passenger traffic and credit card outstanding may indicate an uptick in urban demand, but the point is that overall private final consumption is still largely non-discretionary, with food (30 percent of total), transport (15 percent) and housing (10 percent) being the top spends besides services. Data also show that consumer durables are only about 3-4 percent. This consumption pattern is typical of a low per-capita income economy with high-income inequality. But consumption growth will continue to drive GDP though food price inflation could pose a threat.
As regards the revival of investment activity, the evidence is not very strong. The growth in steel consumption and cement output are perhaps more due to increased investment in housing and services sectors, not manufacturing. Industry-of-use data on Gross Fixed Capital Formation (GFCF) clearly reveals that real estate, housing (23 percent) services (35 percent) and manufacturing (18 percent) were the major sectors of investment while data by asset-type corroborates this (over 55 percent of investment were in buildings and structures, with only about 34 percent in plant and machinery). The share of manufacturing in GFCF has actually been stagnant at around 18 percent for more than ten years now.
Lag In Investment
As for bank credit, the 15 percent growth in the current year (till May 2023) was mainly in personal loans and NBFCs. Industrial credit grew by only 5.7 percent; importantly, over half of it was for working-capital purposes, not project investments, another pointer to the fact that capex was not taking off. Personal loans, which finance the consumption component of GDP, are now the largest category at 30 percent of bank credit. Whether for reasons of risk aversion or a paucity of projects, the pattern of bank credit growth does not suggest any marked pick up in investment activity in industry. To be sure, exports, especially services, are a bright spot but they hinge on the prospects of world economic growth. The question then, both for the RBI and government, is about what would it take to revive animal spirits in industry — interest rate cuts, fiscal incentives or infrastructure programs with greater private sector involvement?
SA Raghu is a columnist who writes on economics, banking and finance. Views are personal, and do not represent the stand of this publication.
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