This is the time of the year when it is customary to take stock of things and revisit forecasts for the second half of the fiscal year. A number of my peers in the forecasting community seem to agree that a number of the assumptions we made in March seem to be going awry and a hasty return to the drawing board seems imperative.
Where have we gone wrong? For one thing, inflation hasn’t quite behaved the way we predicted and instead of dipping south of the seven per cent mark has stayed well above this level. Food inflation, quite predictably has played party pooper with a print of close to 11 per cent for June. Surprisingly, despite a record output of food-grain in 2011-12 and bloated buffer stocks, rice and wheat inflation has been high and has added to the more “secular” inflationary pressures in things like fruits, vegetables and proteins. Rupee depreciation (again much larger than what most of us had predicted) has also played a role at the margin and has offset the benefits of declining global commodity prices. The bottom-line has been that the prediction that the RBI would ease up on interest rates quite quickly this year doesn’t quite seem to be working out. The central bank seems to be making it quite clear that despite some fairly clear signals of softening growth, its focus is still on inflation that is well above its tolerance level. Thus a turn in the growth cycle riding on monetary accommodation might not be on the cards.
The biggest risk to the downside to the growth forecasts and upside for inflation stems from the failed monsoon. The jury seems to be out on whether the summer crop of rice will be affected substantially or not, given the fact that quite a large part of the cropped land happens to be irrigated. However there seems to be little doubt about the fact that things like pulses and oilseeds could see a sharp contraction in output. Supply problems in fruit and vegetables have now become an enduring feature of the food economy and poor rains are likely to make matters worse. Rain shortage will take a toll on moisture content in the soil and have a knock-on effect on the winter crop.
Given all this, it is perhaps sensible to assume that agriculture will either contract this year or stay flat. Since a number of us started with the assumption that (with a normal monsoon) agriculture would grow at roughly three per cent this year, this dip in growth would easily shave off close to half a percentage point from our growth forecasts.
However, this is perhaps the more trivial bit. The key question to perhaps ask is how much this decline in agriculture and farm incomes would affect the industrial and service sectors. Some economists (including myself) have held the view that over the last couple of decades, the non-farm sector has decoupled considerably from the agricultural cycle. Thus a decline in agricultural growth need not compromise the prospects for industry or services. 2004-05 is an example. Agriculture grew at a meager 0.2 per cent but industry grew at 9.8 per cent and services at 8.1 per cent. 2009-10 saw a similar phenomenon.
Using these precedents might however be a tad misleading. In 2004-05 and 2009-10, there were other components of demand that picked up the slack left by slow rural demand. In 2004-05 it was a combination of sharp increases in investment and export growth that provided a buffer. In 2009-10 it was fiscal stimulus (both in response to the global crisis and de-facto stimulus such as the farm loan waiver and spending on the NREGA) that propped up private consumption and government-led investment demand that countered the effect of slowing rural expenditure.
None of these buffers are in place this year. Investments are weak; exports are in the dumps and fiscal stimulus is out of the question. The net result is likely to mean a more substantial impact on industry of the decline in agriculture this year than in the past. Domestic services cannot grow in isolation and the effect of poor agricultural growth (and sluggish rural incomes) will take a toll both directly and through the indirect impact of slowing industrial growth. Thus a parallel can perhaps be drawn with the situation in 2002-03 when all three sectors — agriculture, industry and services — collapsed. Some of us had earlier pooh-poohed the prospect of sub-six per cent growth this year. Now it seems a distinct possibility.
The only thing that could theoretically work in our favour is the depreciated currency. This could give exports a leg-up and by encouraging import substitution switch demand towards domestic producers. A couple of things need to be borne in mind though. Indian exports are far more sensitive to income growth than exchange competitiveness. A moribund America and Europe and a slowdown in China can hardly help matters. Yes, the trade deficit has shrunk over the last couple of months on the back of falling imports. However, whether this decline is the result of a demand switch to local producers or just the result of a slowing economy that has discouraged the import of inputs is an open question. Anecdotal evidence seems to suggest that import substitution is patchy and is being done largely by small producers in areas like polymers and yarn. In other sectors it is simply not technologically viable to source inputs locally.
Annus horribilis yet again?
The writer is chief economist, HDFC Bank