Most shoots are not yet fully green

Last month, when the government announced that industrial output declined 2.3 per cent for the month of March, it was seen as the definite signal that economic growth in India was far from bottoming out. Except for consumer durables, which showed a surprising jump, other segments reported lower output.

Stock market indices, which were on the brink due to the election-result frenzy, ignored the data and soared nearly 3 per cent that day. The market was promptly dismissed as being out of touch with reality and it was predicted that the recovery in stock prices would soon fizzle out.

A month later, the government announced the industrial output data for April. This time, to all round relief, industry expanded 1.4 per cent. It was also revealed that the previous month's reported contraction was exaggerated and that the revised rate of decline, which may be revised again next month, was only 0.75 per cent. If the elections had led to a hung parliament and the equity markets had turned weak again, this data would not have caused a flutter. But, by then the mood had changed so dramatically after the UPA government's return to power that this data release was seen as the boldest green shoot as yet for the economy deemed to be on an assured path to recovery.

In the excitement, not many bothered to look deeper into the data. If not for a surprisingly high pace of growth in electricity generation, aggregate output would have barely moved from last year's levels. Manufacturing, which accounts for nearly 80 per cent of industrial output, expanded just 0.7 per cent. Capital goods output declined for the second successive month. Consumer non-durables production went down 10.4 per cent. But, consumer durables output growth gathered pace to an impressive 16.9 per cent.

The most widely accepted theory to explain the accelerating growth in consumer durables is that government employees are burning up their entire salary arrears bonanza in new cars, television sets, music systems and so on. It is indeed possible that the good demand for recently launched low-cost housing projects is fuelled by the large arrears paid out to government staff. Lottery winners do go on shopping binges, but they are usually short-lived. So, if this explanation holds true, consumer durables demand should see a decline in the coming months. If that happens, what else can drive industrial growth?

Unless demand in the developed markets revives in a big way, export-oriented manufacturing will remain weak. The stronger rupee is already making life more difficult for exporters and if the Indian economy and equity market outperforms as expected, it will become even worse as the rupee appreciates further.  Same goes for service exporters, including software developers and outsourcers. Tourism revenues and remittances by Indians working abroad cannot be expected to show any meaningful growth this year.

It is doubtful that corporate India will resume the investment spree so soon after the slump. Though corporate profits has not fallen as much as feared, confirmed by advance tax payments almost at the same level as last year, not many investment intensive sectors have started seeing substantial demand growth. Most of them are coming out of a demand downswing and are cautious, as the decline in capital goods output for the last couple of months shows. Power generation and telecom are probably the only sectors where companies are ready to roll out big ticket investments. Then again, power plants are long gestation projects which often get delayed and it remains to be seen how fast the new telecom players roll out their networks.

If the corporate sector was less cautious with new investments, it would have already reflected in credit growth. The reverse is happening. Total outstanding bank credit has steadily declined since March and year-on-year credit growth has halved from the nearly 30 per cent level seen last year.

Of course, the property developers have turned aggressive again. Though they are still under heavy debt load and property prices are yet to bounce back, developers are launching new projects, mostly in the economy or low-cost segment. Some of these launches are to raise cash when there is demand for low-cost homes, as the alternative of selling large parcels of land may not be easy in a weak market. Developers like Unitech, Sobha and HDIL are planning to raise capital as their share prices have recovered. But, bulk of these funds will likely go to retire costly debt and not to finance new projects. As any substantial increase in income growth of private sector employees is unlikely in the near term and interest rates can possibly trend higher, it is difficult to see demand picking up further to absorb fresh supply without dampening prices further. Considering these factors, it remains to be seen if the renewed enthusiasm among the builders sustain for long.

Yes, there is the big hope of a significant scaling up of public investment in infrastructure in the next budget. Undoubtedly, the new government would want to do that. But, considering the jump in fiscal deficit, the government cannot easily step up spending. Many argue that the government should forget about the deficit for this year and just increase budget outlays for critical sectors. Presuming the government will be equally prudent and disciplined in scaling back its spending programmes in subsequent years, there is some merit in that argument.  Even then, the political pressure to expand some of the pet projects of the new government will likely take up the bulk of the enhanced budget outlays.  Some initiatives, like the Urban Renewal programme for which the World Bank may lend $5 billion, will be partly funded by multilateral lending. Again, such programmes will be spread over many years and their near term impact will be limited.

The government has placed its bet on further gains in the savings rate to help economic growth. As many economists and commentators have pointed out, the Indian economy's shift to a higher growth trajectory since 2003-04 was made possible by a substantial increase in savings. However, a good part of these gains was because of the improvement in government finances which reduced the 'negative' government savings when compared to earlier years. Steady growth in corporate profit margins was another factor. With higher fiscal deficit, the public sector will pull down the savings rate. Considering the pressure on corporate profit margins and the restrained growth in household incomes, it is unlikely that the private sector will pick up the slack.

Foreign capital can make up for a decline in domestic savings, but the FDI trends for the last several months are not very encouraging. Even assuming that FDI flows will pick up from now on as India is expected to grow faster than the rest of the world except China, it is doubtful that they will reach the record highs seen last year.

Finally, there is the interest rate outlook. Just the base effect would ensure that wholesale inflation will jump from around September onwards. Consumer inflation has stayed above or close to double digits even when the wholesale index was threatening to go into deflationary territory. The RBI's policy options will be highly restricted in such a scenario. Add the substantial increase in new government bond issues, interest rates are likely to trend higher before long.

No, I am not a pessimist. Like most others I too believe that economic growth has most likely bottomed or at least is very close to doing so. But, the excitement about a swift recovery is another matter. I am not yet ready to buy into that.

See: Great Recession to just another regular recession?