India's Weakest Growth in Six Quarters

GROSS domestic product (GDP) growth in India continued to slide falling to 7.7 per cent in the first quarter of the current financial year (April-June 2011-12), against a 7.8 per cent growth in the preceding quarter and an 8.8 per cent growth recorded in the first quarter of the previous year (according to the revised estimates based on the new series of IIP). The country's GDP at factor cost at constant (2004-2005) prices stood at Rs12,26,339 crore, as against Rs11,38,286 crore in the first quarter of the previous fiscal (2010-11), according to figures released by the Central Statistical Organisation (CSO). Sectors driving the first quarter growth include electricity, gas and water supply (7.9 per cent), trade, hotels, transport and communication (12.8 per cent), financing, insurance, real estate and business services (9.1 per cent). As per the latest estimates of the index of industrial production (IIP), growth in the index of mining, manufacturing and electricity slowed to 1.0 per cent 7.5 per cent and 8.2 per cent, respectively, in April-June 2011-12 against growth rates of 8.0 per cent, 10.3 per cent and 5.4 per cent, respectively, during the first quarter of the previous fiscal. GDP at factor cost at current prices is estimated to have grown 16.7 per cent year-on-year to Rs19,37,123 crore during the first quarter of 2011-12 quarter, against Rs16,59,708 crore in the corresponding period of 2010-11. The sector-wise breakdown showed that the construction sector had been one of the worst-performing parts of the economy.

Construction grew at 1.2%, down from 8.2% in the previous quarter, as rising interest rates and delays in planning approvals held up building projects. Agricultural output rose 3.9%, which was down from the previous quarter but above the level of 2.4% in the same period last year. Manufacturing grew 7.2%, an improvement from the previous quarter, but well below the 10.6% in the corresponding quarter of 2010-11.Private final consumption expenditure (PFCE) at constant (2004-05) prices is estimated at Rs7,95,683 crore in Q1 of 2011-12 against Rs7,48,395 crore in Q1 of 2010-11, while Government final consumption expenditure (GFCE) at constant (2004-2005) prices is estimated at Rs1,36,935 crore in Q1 of 2011-12 against Rs1,34,161 crore in Q1 of 2010-11. Gross fixed capital formation (GFCF) at constant (2004-2005) prices is estimated at Rs4,10,533 crore in Q1 of 2011-12 against Rs3,80,544 crore in Q1 of 2010-11.

The first GDP numbers for the current fiscal confirm several analysts’ assessment of economic prospects for the financial year which would involve further moderation in growth due to stricter monetary policy to curb inflationary pressures. Signs are already visible as according to data from the Centre for Monitoring Indian Economy, new investment announcements by companies have more than halved to Rs 32.5 lakh crore during April-June 2011 from Rs 71.4 lakh crore in the corresponding period last year as high interest rates, decline in demand and policy uncertainty have taken a toll. Declining investment can only aggravate inflationary pressures as supply–side bottlenecks increase. While the 7.7 per cent growth silhouetted against a murky

New Investment Announcements
Industry	Apr-Jun 2011-12 (Rs. Crore)	%change over April-Jun 2010-11
All	32,53,158	-55
Manufacturing	13,31,621	-52
Electricity	9,02,591	-61
Cement	30,000	-83
Services (Non-financial)	6,85,889	-59
Source: Times of India, 1st Sep, 2011

global scenario seems impressive, given the estimated requirements that we spoke about in our previous blog, a 7.7 per cent and slower future growth could well jeopardize a lot of calculations on achieving deficit targets as well as infrastructure development and inclusive growth.

India’s Road to Fiscal Consolidation — Diversions Ahead

Total public debt of the Indian government stood at Rs. 31.5 trillion at that end of June 2011 against Rs. 29.7 trillion at the end of March 2011 according to the June 2011 public debt management report released by the finance ministry. Central government debt rose nearly 6 per cent, but dropped as a percentage of GDP because of a revision in GDP estimates. The gross fiscal deficit (GFD) stands at 39.4 per cent of budget estimates (BE) during the first quarter of 2011-12 compared to 10.5 per cent at the same time last year. The major reason for a worsening fiscal situation is the fall in receipts, particularly non-tax receipts. Revenue and non-tax receipts were at 11.5 and 9.7 per cent of BE respectively during Q1 2011-12, compared with 29.3 and 78.2 per cent respectively during Q1 of last fiscal. The fiscal outcome during the first of quarter of 2011-12 indicates that all the key deficit indicators as percentage of budget estimates (BE) for 2011-12 were substantially higher than their levels during the corresponding period of the previous year because of lower revenue collections both from tax and non-tax sources. Gross tax collections during the quarter at 6.6 per cent of BE were lower than 8.3 per cent a year ago. In the direct taxes, corporation tax collections showed a negative growth of (-) 27.8 per cent while personal income tax increased by 6.5 per cent as against budgeted growth rates of 21.5 per cent and 16.2 per cent, respectively, for 2011-12. All the major indirect taxes (customs, excise and service tax), however, showed buoyant growth rates (37.7 per cent, 23.2 per cent, and 31.1per cent, respectively) during April-June 2011 as against budgeted growth rates (15.1 per cent, 19.2 per cent and 18.2 per cent, respectively) for 2011-12. This, combined with the facts that India's high savings rate allows a larger share for internal debt (90.3 per cent of public debt, at end-June 2011) vis-à-vis other countries and a small share of external debt along with a comfortable maturity profile improves the credibility of government debt and increases sustainability, gives some reason to rejoice.

India’s central bank in its recently published Annual Report has asked the crucial question whether the fiscal consolidation witnessed in the fiscal year 2010-11 is sustainable or not. The RBI mentions that the fiscal deficit ratios in 2010-11 turned out to be better than envisaged in the Union budget as the Central government’s gross fiscal deficit (GFD) was 4.7 per cent of GDP against 5.5 per cent budgeted. This compared with a GFD of 6.4 per cent of GDP in 2009-10 was indeed impressive. However, the RBI notes that a qualitative assessment of fiscal correction during 2010-11, raises concerns as improved fiscal position had a large temporary component arising from a business cycle upswing and one-off non-tax revenue gains from spectrum auctions, which resulted in the improvement in headline deficit numbers. Not accounting for the revenue proceeds of two main one-off items – spectrum auction and the disinvestment – the GFD/GDP ratio works out to be 6.3 per cent of GDP during 2010-11. Also, revenue buoyancy was supported by a cyclical upswing in the global and Indian economy that led to above trend growth. So the one-off gains and higher growth in nominal GDP of 20 per cent against the budgeted 12.5 per cent contributed largely to lower deficits. Moreover, not only did the correction in revenue account reflect more than- anticipated revenues there has been a spillover of subsidy expenditure from the last quarter of 2010-11 to the current fiscal year. Although the share of capital expenditure in total expenditure increased in 2010- 11 from 2009-10, it was marginally lower than the budget estimates. In particular, capital outlay-GDP ratio fell short of the budgeted ratio in 2010-11 and is still significantly lower than that achieved during pre-crisis period. Consequently, in outstanding terms, the Central government’s capital outlay (as ratio to GDP) as at end-March 2011 was lower at 12.9 per cent than 13.8 per cent a year ago.

Further, both internal and external dynamics could well alter the course of fiscal consolidation taken during 2010-11. The darkening external environment leaves little space for complacency as export revenues are very unlikely to remain elevated particularly if the downturn in the US and EU/UK affect the demand for exports, and particularly software exports, as also a prolonged recession like scenario in the developed world may destabilize India’s so far successful strategy of expansions in export destinations. Domestic demand is being curbed through tight monetary policy to fight inflation, however, the hardest hit has been investment demand which has started to show up in slowing growth and dwindling revenues. Growth projections have been revised down in the range of 8 to 7 per cent by several agencies (see www.ecofin-surge.co.in); falling growth and inflation eating into budgets leaves little room for any expectations of tax buoyancy. India has also lost some of its attractiveness as a destination for international capital flows due to staggering growth; short-term portfolio flows have seen reversals and the Indian stock market gains in 2011 have been much lower than some of the Asian markets. Given the strong positive relation between international flows and public debt, India should be wary as India’s public debt to GDP ratio is among the highest in the region (the ratio stands at 69.2 per cent for India in 2010, compared with 17.7 per cent for China, 26.9 per cent for Indonesia, 44 per cent for Thailand and 54.2 per cent for Malaysia, according to the IMF, WEO Database). On the other hand getting back to the concerns on the Indian economic outlook raised by RBI which mentions that apart from monetary tightening, complementary policies to lower inflation and inflation expectations need to be put in place including improved supply response for food, higher storage capacity for grains, cold storage chains to manage supply-side shocks in perishable produce and market-based incentives to augment supply of non-cereal food items, management of water as also technical and institutional improvements in the farm sector and allied activities. Further, the infrastructure gap of India, both in relation to other major countries and its own growing demand has been a key factor affecting the overall productivity of investments. As per the assessment of the Planning Commission, during the Twelfth Plan (2012-17) India may need infrastructure investments of over US$ 1 trillion. Fiscal consolidation and reorientation of expenditure towards capital expenditure is necessary to meet such targets. The RBI rightly points out that the challenges faced by the Indian economy that are constraining growth relate to education, health, energy, infrastructure and agriculture sectors, where public policy interventions are needed as markets by themselves may not be able to do enough to remove the constraints. Thus, we have reason to believe that addressing these concerns in all seriousness could well call for policies that lead to a diversion, may be a welcome one, in the road to fiscal consolidation.