A low growth, low inflation phase

GVA decline can be due to late impact of demonetisation and destocking activities undertaken pre-GST

The Q1 GDP data released on August 31 was disappointing. Beneath the data internals however, there are some stark realities which are important to understand for better policy decision making.

To begin with, nominal gross value added (GVA) increased by only 7.9 per cent in Q1. Thus, we don’t agree with the Central Statistics Office narrative that increase in Wholesale Price Index prices/higher GVA deflator (GVA deflator declined from 5.4 per cent to 2.2 per cent) was one of the reasons for the slowdown. The decline of GVA could be due to factors like the lingering impact of demonetisation and destocking activities undertaken pre-GST (goods and services tax) implementation. Let us now examine these factors in greater detail.

Industry grew by 4.5 per cent in Q1 FY18 (7.4 per cent in Q1 FY17), owing to a significant decline in mining (-0.7 per cent) and miniscule growth in manufacturing (1.2 per cent). The negative growth in mining is quite surprising (the average of last three years’ first quarter mining growth is 9.8 per cent) as mining activity is generally buoyant in the pre-monsoon season. We believe Coal India is shutting down mines across some states as state electricity boards are now sourcing in part their electricity requirement from renewables, negating the demand for coal. As the RBI (Reserve Bank of India) Annual Report emphasises, “In the power sector, higher capacity addition in renewables may pose multiple challenges with regard to the integration of renewables into the electricity grid and the possible dampening effect on already worsened thermal Plant Load Factor (PLF).”

The slow growth in manufacturing GVA is quite consistent with the negative growth in corporate GVA as both are correlated. The corporate GVA decelerated since Q3 FY17 and exhibited negative growth of 8.4 per cent in Q1 FY18 (based on the data of 2,210 non-financial companies). Additionally, a closer look at the inventory destocking from the GDP data indicates that while it is true that this has happened on a q-o-q basis (a 3.8 per cent decline in Q1 FY18 over Q4 FY17 at constant prices but still lower than in Q3 FY17 over Q2 FY17), there is still an increase of 1.2 per cent on a y-o-y level. There have been similar declines in Q1 of FY17 and FY16 also on a q-o-q basis. Clearly, the slowdown in manufacturing should be looked beyond the prism of destocking.

The low growth in agriculture in Q1 FY18 was not entirely unexpected as the average growth in the sector in the first quarter of the last five fiscals was a meagre 2.5%

Agriculture and allied activities grew at 2.3 per cent in Q1 (vis-à-vis 2.5 per cent). This low growth was not entirely unexpected as the average agriculture growth in first quarter of the last five fiscals was 2.5 per cent. However, the concern is nominal GDP growth in agriculture is nearly zero. Agriculture, which accounts for 17 per cent of the GDP, is showing signs of glut. This does not translate into purchasing in rural areas, thus denting the demand. The GVA deflator for agriculture was negative in Q1 FY18, the first time since Q2 FY15.

Service sector growth jumped to 8.7 per cent and this was a saving grace. However, the growth rate in this sector was under fortuitous circumstances, as the trade sub-segment growth jumped because of destocking, but also the communication and hotel segment contributed through increased competition with the entry of Reliance Jio and arrival of foreign tourists.

In fact, the contribution of any possible destocking had both a positive and negative impact on GDP. Thus, while manufacturing sector weighted contribution growth declined by 80 basis points, there was an exact 80 basis point increased contribution in the trade sub-segment within services. Thus, to be fair, the impact of GST was neutral across sectors.

The sub-segment financial sector growth improved markedly to 6.4 per cent in Q1 on a sequential basis, because of a push in professional services (around 73 per cent share). We believe the growth in professional services is because of hiring of consultancy services by corporates ahead of the implementation of GST and insolvency code. The public administration sub-segment expanded by 9.5 per cent driven by a 25 per cent jump in real government revenue expenditure net of interest payments.

Going forward, we believe the growth of manufacturing and service sectors may turn out weak in Q2 as the destocking in manufacturing sector activity has well continued in Q2 at least till mid-August. As far as the service sector is concerned, the growth in trade segment will moderate from high levels with GST being implemented. The government sub-segment may see a slowdown as there has already been a lot of frontloading of expenditure in Q1 FY18. The banking sub-segment, however, may continue to grow with higher demand for consultancy services probably continuing.

So, what next? We are possibly in a situation of low (g)flation, implying low growth and low inflation. On a lighter vein, note that the word g stands for growth and is silent indicating that in any discussions of inflation growth trade-off in the Indian context, growth perhaps takes the backseat. While it is imperative to stick to the path of fiscal consolidation, there is no harm if the government spends the possible windfall arising out of GST on pushing capital expenditure ahead rather than shoring up the revenue mobilisation numbers. Any cutback in expenditure at this point will be deflationary when private investment is unlikely to be forthcoming unless resolution starts happening in Q4 FY18.

We would also expect the government to start sorting out some of the nit-pickings of GST implementation in the interregnum and not change the GST rates too often. For example, take the real estate sector. There is an 18 per cent GST on real estate now. However, there is an abatement of 1/3rd for value of land, bringing down the effective GST rate to 12 per cent (except low-cost housing). It was expected that the builders will reduce the price of flats as they now get input tax credit. But this has not happened and the buyer is paying the entire GST. Clearly, the builder is to be nudged to reduce the prices, as only then the GST benefits will be beneficial. Also, the housing sector needs a big push by the government in the quest for more employment opportunities.

The author is group chief economic advisor, State Bank of India. Views are personal