By Invitation. The growth conundrum

Never before have quarterly economic growth estimates generated as much curiosity and been awaited as eagerly as the data for October-December 2016 (Q3 FY2017), the quarter in which the note ban was introduced.

The forecasts released by the Central Statistical Office (CSO) have thrown up some unexpected trends.

In real terms, the growth of India’s gross value added (GVA) at basic prices has been estimated at 6.6 per cent in Q3 FY2017. This is higher than forecast by us and other market participants, all of whom were trying to gauge the macro impact of a black swan event with little data, some anecdotal evidence and a surfeit of opinions.

Moreover, the pace of GVA growth for Q1 and Q2 FY2017 has been revised downward to 6.9 per cent and 6.7 per cent, respectively. The mild incremental slowdown in growth to 6.6 per cent in Q3 FY2017 appears to brush off the impact of the note ban, in contrast to anecdotal evidence of stress in various cash and labour-intensive sectors. To be fair, this is partly on account of the near-normal monsoon in 2016, which boosted the pace of growth of agriculture, forestry & fishing to a series-high 6 per cent in Q3 FY2017.

When we remove the farm sector from the analysis, the growth of GVA excluding agriculture moderated quite sharply from 7.8 per cent in Q1 FY2017 to 7.1 per cent in Q2 FY2017, and relatively modestly to 6.7 per cent in Q3 FY2017.

Moreover, the revised data released by the CSO reveals a sharp dip in GVA growth to 6.8 per cent in H1 FY2017 from 8.1 per cent in H1 FY2016, indicating that a slowdown had set in well before the note ban was announced.

By design, the early estimates of quarterly GVA rely heavily on available data for the formal sector, which is expected to have weathered the note ban better than the informal sector.

Therefore, the Q3 FY2017 GVA growth of 6.6 per cent may not be fully capturing the impact of the demonetisation. Subsequent estimates that draw from wider data sources may revise Q3 FY2017 growth downward.

The Reserve Bank of India had initially opined that the impact of the cash crunch may be transient, followed by a strong rebound in growth. We have parsed various indicators for production and consumption for January 2017, to glean a preview for what lies in store in Q4 FY2017. Unfortunately, a broad-based improvement in economic activity does not appear to have set in.

On the positive side, while automobile production continued to contract, the pace of the same eased considerably to 5.5 per cent in January 2017 from 21.8 per cent in December 2016, with a receding of the inventories that had built up in November 2016. The growth of domestic airlines’ passenger traffic remained in excess of 20 per cent in January 2017.

Moreover, rail freight displayed a marginal growth in January 2017, following the contraction in December 2016. The YoY growth of coal production rose mildly in January 2017, even though power demand remained moderate.

In contrast, growth of non-oil exports and cargo handled at major ports eased in January 2017.

Consumption of diesel, which spans demand from logistics as well as captive generation in industries, agriculture and households, and petrol contracted in January 2017, reflecting the continuing sluggishness in economic activity and rising fuel prices. Given the mild slowdown in Q3 FY2017 GVA growth, the rebound in growth in Q4 FY2017 is unlikely to be strong. In fact, some moderation in agricultural growth may well weigh upon the Q4 FY2017 GVA expansion.

At present, we concur with the CSO that full year GVA growth in FY2017 would print at around 6.7 per cent, lower than the RBI’s estimate of 6.9 per cent.

The key themes for the coming fiscal year include a continued proliferation of digital transactions and the introduction of the Goods and Services Tax, both of which will likely reduce the competitiveness of the unorganised sector.

With reservoir storage trending in line with the FY2015 levels, albeit considerably lower than FY2014 levels, the dynamics of the monsoon in 2017 would crucially affect agricultural output, rural incomes and demand. However, early signs do not portend an above-normal monsoon in 2017.

With some moderation in consumer sentiment after the demonetisation and a subdued likelihood of another repo rate cut, we expect the private sector to delay investment in fresh capacity to H2 FY2018, until capacity utilisation becomes healthier.

The writer is Principal Economist, ICRA Limited

COMMENT NOW