The Indian economy presents a puzzle today. On the one hand, it exhibits many symptoms of overheating. On the other hand, many businesses complain of a complete lack of heat. GDP projections reflect the second phenomenon, not the first. But I suspect data revisions will ultimately show GDP to be somewhat better than suggested by the latest dismal estimates. ` The current account deficit in 2011-12 was 4.2%, and the fiscal deficit was 5.9% of GDP (against the budgeted 4.8%). Both were signs of overheating. Moreover, consumer price inflation was almost in double digits, and every sector from agriculture and construction to industry and services complained of labour scarcity.
These trends have continued in the current financial year. The current account deficit came in at a record 5.4% of GDP in the second quarter of 2012-13, and Citibank estimates the annual number at 4.7%. The fiscal deficit would have been as large or larger than last year’s but for recent Herculean efforts by P Chidambaram to slash spending (mostly productive Plan spending), and by deferring many payments (like dues to oil and fertiliser companies) till the next fiscal year.
Inflation has continued high through most of the fiscal year. Wholesale price inflation has at last dipped to 6.6% in January, but consumer price inflation remains sky-high at 10.8%. Complaints of scarce labour have not weakened.
In sum, we have had signs of an overheated economy for two years. Yet, in the same period, we have also seen a dramatic fall in production, consumption and investment intentions, and overall economic sentiment. These are all signs of a flagging economy, and point in the very opposite direction of overheating.
After hitting 9.2% in 2010-11 —largely because of a big recovery of agriculture after a drought in the preceding year — GDP growth crashed to 6.5% in 2011-12. The CSO now projects it at just 5% in 2012-13 —implying a still lower figure of 4.7% for the second half of this fiscal year. Even this sombre CSO projection assumes industrial growth of 3.1% for the year, whereas actual growth of the index of industrial production in April-December was a pathetic 0.7%. Even worse was the performance of exports, which declined 4.6% during April-January.
Other macro figures also show terrible weaknesses in the economy. The CSO projects private consumption this year to rise by only 4.1%, after consistently exceeding 8% in recent years. Growth of public consumption is projected to slow to 4.1% this year from 4.4% last year. Fixed capital investment growth is projected to slow to 2.5%, from 4.4% last year and double-digit figures in the boom years.
How do we reconcile the data showing overheating with data showing terrible weakness? Some economists claim that high inflation proves that India is supply-constrained. But many corporates complain of slack demand and low capacity utilisation, above all in the capital goods sector.
Fuel shortages have affected power production. Yet, the paradox is that power generation has done perfectly well this year, with around 5% growth. This has not translated into higher manufacturing, so presumably power shortages have eased. In the past, manufacturing grew twice or faster than power generation. That relationship has suddenly reversed.
We have no really good explanation why an investment rate of around 35% of GDP — and higher power generation — has suddenly stopped translating into strong growth of production. A partial explanation comes from CMIE, which says the number of stalled projects has shot up. Because of this, new project proposals have plummeted. That explains the falling order book for capital goods. But it does not prove a generalised collapse of demand.
Some economists say the problem is stagflation — a mixture of stagnation and inflation — arising from deep structural problems. In the 1970s, many western countries attempted to use large Keynesian deficits to stimulate growth, but ended up stimulating inflation — hence the phrase stagflation.
However, this is not a good description of what’s happening in the country. Despite the slowdown, 5% GDP growth is surely too fast to be called stagnation. The fiscal deficit is indeed translating more into inflation and imports than domestic production. Yet, stagflation typically means high unemployment, whereas India is experiencing labour shortages.
One day, data revisions will give us a better grasp of the situation. I suspect the production data will be revised upwards as the finance minister has claimed.
The latest trends in Purchasing Managers Indices suggest an upturn. And FMCG companies had 15% sales growth during September-December, a modest slowing rather than a crash in demand.
Economies rarely crash from 9% to 5% growth unless there is a crisis, war or natural disaster. India has not faced any such disasters. Its longterm economic drivers remain intact. Seen in perspective, its current performance looks too bad to continue long. The factors stalling projects and causing delays are being addressed, and environmental and other clearances are being expedited. This should soon lead to an upturn in the economy. This amounts to an optimistic interpretation of the paradox of overheating and heat loss at the same time.