How real is the recovery?

Lack of new investments may undermine higher consumption

Three recent events have brought back the debate about the nature of an economic recovery into sharp focus. One, the monsoon has come good and brought cheer across the economy. The obvious positive impact on agricultural growth is expected to stimulate the rural economy. Two, on the urban front, the increased payouts on account of the Seventh Pay Commission's award are expected to do the same for raising overall demand. The third factor is the coming together of political parties to usher in the goods and services tax, which is expected to pave the way for greater efficiency in the market. Seen in this context, the rising valuations in the stock markets may not seem odd. True, corporate performance in the June quarter has not been encouraging, but firms with a larger dependence on domestic consumption are expected to do much better going forward. Car and two-wheeler companies, for example, have already started showing encouraging sales growth.

Yet, the debate about recovery persists for a variety of good reasons. In fact, looking at another set of data, observers could be justified in asking: "What recovery?" For one, there are several reasons why the uptick in rural demand may not really happen to the extent hoped for. That's because of the deep-set indebtedness in rural households. The average per household debt has increased from Rs 7,539 in financial year 2001-02 (FY02) to Rs 32,522 in FY12 - a jump of over 300 per cent. The droughts of FY15 and 16 made matters worse. Given that nearly half the rural borrowing still happens from non-institutional sources, how much of the improved earnings from this harvest will trigger consumption and how much would be used to retire debt is an open question. On the urban consumption front, there are two reasons why the expected consumption spurt may not happen. One, the data from eight employment-intensive industries had suggested a sharp fall in job additions between FY15 and the first nine months of FY16. Together with the urban wage growth being at a seven year low, according to one index by Citi Research, it is clear that there are structural reasons that may pull down urban purchasing power.

But a consumption-driven demand spurt, to the extent that it happens, will only result in a short-term recovery. For a sustainable recovery, investment levels have to go up. This aspect is brought out by the dramatically different performance of two key indicators that one expects to go together. On the one hand, the core sector data show marked improvement over the past two quarters, especially in sectors like coal and cement. However, this is contrasted by an equally anaemic index of industrial production. The oddity, of course, is that the core sector accounts for 38 per cent of the IIP and yet, as a Care Ratings research shows, the two variables have moved separately since the start of FY12.

What has essentially happened lately is that the core sector, which in IIP terms, comprises basic and intermediate goods, has grown on the back of the government's infrastructure push - roads and railways - as well as more transparent mining auctions. Yet, the capital and consumer goods indices within the IIP, together accounting for 39 per cent, have contracted in four years (capital goods) and three years (consumer goods), respectively, out of the past five years. As such, even while consumption may improve a little this year, the expected recovery will peter out if capacity utilisation rates do not go up significantly and fresh investment does not happen.