By Pranjul Bhandari
india s economic growth is slowing. We examine these growing pains and answer four frequently asked questions. Here are four questions we are often asked on India’s growth:
Is growth slowing?
Yes, growth has hit a soft patch. Potential growth, by our calculations, is currently around 7%. Actual growth is likely to come in at 6% for the quarter ending March 2019. Of the 40-odd indicators of growth we track, about 70% are weaker than before. Data over the last three months suggests consumption demand has been slowing (proxied by car sales and IIP consumer goods production).
This is weighing in on overall manufacturing (proxied by IIP manufacturing and PMI manufacturing). Alongside this, construction activity has been slowing too (proxied by the IIP Infrastructure and construction index and a recent sequential dip in cement production). The global environment is not helping either. Exports have been sluggish. On the other hand, it is fair to point out that capacity utilization has ticked higher. And bank credit growth has also risen. As such, not everything is in the doldrums.
Is it a credit growth problem?
While NBFCs credit is likely to have softened, commercial banks have picked up the slack. We see a notable rise in personal loans (particularly housing), construction, and infrastructure(particularly roads). We also find that industrial credit has ticked higher than before (see accompanied graphic). On the other hand, bank lending to NBFCs and unsecured personal loan growth have softened, albeit from high levels of growth . Overall, the flow of funds to the commercial sector is higher than before.
As such, system-wide credit may not be a huge problem, although NBFCs led sector-specific stress could remain. As banking sector liquidity improves over the next few months, and the cash-to deposit ratio moderates after having sprung up last year, bank credit could rise further (this will be reflected in the money multiplier rising back up).
Is the slowdown structural? Or cyclical?
It is easy to confuse a structural slowdown with a cyclical slowdown. Our analysis suggests that both factors are at play in India. Potential growth has been falling; from 8% a decade ago to 7% currently (see accompanying graphic). The global environment has been marked by low growth and increased volatility over this period. Two of the three drivers of growth capital (K) and labour (L) have weakened considerably.
The third driver, Total Factor Productivity (TFP), had weakened, but has risen back up as some of the recent reforms have been TFP-enhancing. However, the fall in K and L have outpaced the rise in TFP, thereby lowering potential growth.
Cyclical growth has slowed too, as discussed in the earlier section. It was trending well above the 7% potential, at about 7.5%, over the four quarters before the NBFC fallout of September 2018. Unsurprisingly, this period was associated with elevated core inflation (about 6% y-o-y). Clearly, it was not sustainable and, in retrospect, we know the problems surrounding the NBFC sector were only intensifying during that period. We have the opposite problem today. Growth has been slowing since late 2018, trending well below the 7% potential. Core inflation has also slowed during this time.
We see three reasons for this. One, we have econometric evidence that growth falls right before elections (held over April and May), but rises back up thereafter, as uncertainty fades. Two, the impact of the banking sector liquidity deficit over large parts of 2018 may have been a drag on growth4. Indeed, the money multiplier has been falling recently. Three, the NBFC fall-out has led to sector specific funding stress.
When will it be revived? What’s the policy prescription?
We expect growth to pick up again to the 7% (potential) ballpark in 2H2019. There are three good reasons for this. One, a pick-up in activity, as election-related uncertainties fade. Two, an improvement in banking sector liquidity. We find that the liquidity situation generally improves over the months of June-August (see accompanied graphic). This could push the money multiplier up. Finally, we expect the RBI to remain supportive. We expect a 25bp rate cut in June, taking the repo rate to 5.75%. Thereafter, we expect the RBI to maintain liquidity at a slight-surplus.
As such, we do not think any large policy stimulus is needed to revive growth to 7%. In fact, a large stimulus could do more harm than good . We find that the forward looking real repo rate is no longer too high. The RBI has been cutting rates and inflation, and is expected to tick higher over the next year. On the other hand, the real corporate bond yield is rather high. This, in our view, reflects the crowding out of private activity by elevated public borrowings.
If the intention is to raise growth higher than 7%, the country needs to embark on a new set of reforms.
As discussed in an earlier section, the reforms so far have only focussed on raising one driver of growth, the TFP. Fiscal reforms, and, land and labour reforms are necessary to augment the other two drivers of growth, namely capital and labour. If India wants to raise potential growth to the 8% ballpark, where it used to be a decade ago, we believe it needs to implement a balanced set of reforms .
Edited excerpts from HSBC Global Research s India Economics Report dated May 29
(The author is Chief economist, HSBC Securities and Capital Markets, India. Views are personal)