Momentum continues

Low nominal growth can pose challenges

The Indian economy in the second quarter (July-September) expanded by 7.6 per cent, year-on-year, which surprised most analysts on the upside. Most economists were expecting growth to be around 7 per cent. However, at a Business Standard event in October, Reserve Bank of India (RBI) Governor Shaktikanta Das had said the gross domestic product (GDP) growth number for the second quarter would surprise on the upside. Nevertheless, the RBI retained its full-year growth projection at 6.5 per cent despite the higher than expected growth rate of 7.8 per cent in the first quarter. In terms of sectoral performance in the second quarter, the manufacturing sector expanded by an impressive 13.9 per cent, though it was partly driven by a low base. The manufacturing sector value added had contracted in the same quarter last year. Construction, another labour-intensive sector, expanded 13.3 per cent. The big disappointment, however, came from the agriculture and allied sector, which grew by a modest 1.2 per cent. This suggests there would be pressure on overall food production, which will have implications for retail inflation outcomes.

Given that the economy has expanded by an average rate of 7.7 per cent in the first half of the financial year, full-year growth at 6.5 per cent, as projected by the RBI, will mean significant deceleration in the second half of the year. It is thus likely that the full-year forecast of the RBI and others will be revised. The key now will be if the momentum can be sustained in the coming quarters. An analysis of the second-quarter corporate results showed a sequential decline in the momentum, which could affect growth in the coming quarters. The national accounts data also showed that private final consumption expenditure grew by a modest 3.1 per cent during the second quarter, which is puzzling, given the strong overall growth number. Encouragingly, however, gross fixed capital formation increased by 11 per cent. This indicates a revival in private investment, which is necessary to sustain growth in the medium term. Inflation in advanced economies has come down. Although the inflation rate remains above the target of central banks, which are expected to keep interest rates “higher for longer”, global financial conditions have started easing and will help Indian firms in raising capital. In fact, activity in the primary equity market suggests that even smaller companies are raising capital, which will help push up investment. But if private consumption remains weak, sustaining investment itself could become difficult.

Although overall growth in constant prices looked impressive and was above all forecasts, the focus will once again turn to nominal growth. GDP in nominal terms expanded by just 9.1 per cent in the second quarter. Nominal growth in the first quarter was also marginally above real growth. Low nominal growth can be explained by the weak wholesale price index-based inflation rate, but it could create problems for the government. The Union government is targeting to contain the fiscal deficit at 5.9 per cent of GDP in the current year, with a nominal GDP growth assumption of 10.5 per cent. If the nominal growth trend continues in the second half, it will become difficult to contain the fiscal deficit at the targeted level. A possible reduction in capital expenditure to contain the fiscal deficit might have a direct effect on growth and end up complicating the problem even further.