Time to bail out Households Mr.Modi!

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The GDP numbers came in at a disappointing 5.7%. While it came below estimates, supporters of the Government were quick to point out that this was primarily due to the roll out of the GST. Manufacturing growth, for example, fell from 10% in Q1 2016-17 to 3.8% in Q1 2017-18. While there are merits in the argument, I would like to pick out some trends from the GDP and other economic data that in my view should be discussed and acted upon.

a. The spike in Gold Imports

The GDP data shows that Net of Exports which made up for about (-) Rs 60000 crores in Q1 of 2016-17 went up 2.5 times to (-) Rs 152000 crores in 2017-18. One big reason is Gold Imports.

According to the PIB, Gold Imports spiked 95% in July. It had jumped 103% in June. The argument at the end of June was this was to beat the GST but the continued jump in July belies that hypothesis. The fact is that Gold imports have surged from the early part of this year and not just due to GST. Whatever the reasons, the trade and services deficit is in a mess

As a consequence of this poor export performance during the first 4 months of the year, Trade and Services deficit has increased almost 3 times from 10.8 B in 2016-17 to about 34 B in 2017-18. From a currency perspective, this deficit has been compensated by a massive surge in FPI/FIIs investing in Debt(Government debt), see chart below. It has also been compensated to some extent by improved net FDI flows across sectors.

In other words, we are mostly covering the Trade and services Deficit with Government borrowing from FPIs

b. The spike in Government spending

Thanks to lower crude prices and a massive surge in excise duties along with a creeping increase in service tax, Government spending has shot up in Q1 of the last two years. This year, the Central Government has taken the additional risk of front ending a lot of its borrowing driven spending (a surge that can also be seen in FPI debt purchases) probably to compensate for residual effects of Demonetisation and the full impact of pre-GST behaviors. Either way, the Government spending was unable to stop the fall in growth

c. The secular drop in Private consumption and Gross Fixed Capital formation growth

Over the last 4 years, private consumption growth has fallen from 13.9% to 9.1% this year.

Now, this in itself is not an issue to panic. It becomes a problem when Government spending is not able to fully compensate for this drop. A combination of Private plus Government spending recorded a growth of 10.9% in Q1 2017-18, it was 13.5% last year and 13% in Q1 2014-15. That aside, the Gross Fixed Capital formation growth too has trended downwards over the last 4 years.

GFCF is primarily driven by Private Sector Corporates and the Household sector.

In 2015-16 for example, Private Non-Financial Sector made up for 37% of GFCF, it was 36.7% for the Household Sector. The Household sector made up for 40% of GFCF in 2013-14 while the Private Non-Financial Sector made up for 36.6% of GFCF in 2013-14.

It appears from the data (purely as a hypothesis) that the slowdown in capital formation by the Household sector is not being fully replaced by the Government and Public Corporations. Within the household sector, except for Trade, repair, hotels and restaurants, every other sector appears to be trending downwards. The Government strategy so far has been to focus on Large Corporates rather than the household sector. The World Bank feels that is good enough, time will tell.

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In sum,

The Government has worked hard to fix its balance sheet (by managing expenses prudently and increasing taxes) and also substantially boost spending on infrastructure while improving the overall efficiency of its services. However, it appears (and this is a hypothesis) that this spending, because it is narrowly focussed and has long term impact, is having a limited impact on the economy immediately. The sharp slowdown in the growth of both private consumption (above) and possibly in household gross fixed capital formation is indicative of a larger problem at the household level. I had written earlier that income growth has begun to taper down for households over the last 3 years (due to a mix of low inflation and deterioration in the economic performance of the country)

Chart: % claiming their incomes went up during versus the previous year (6 metro survey)

So it is fairly clear that households need to feel good about their incomes immediately as both the income and consumption trends appear to be moving in tandem.

At a second level, the overall trade deficit and specifically the growth in exports will need a new strategy. I had written last year that a glaring lack of innovation is not helping Exports by much. While it is in many ways a long term solution, other short term and medium term solutions also don’t seem to be helping by much.

The Prime Minister will need to revisit his strategy of high dependence on Government spending and efficiency and work harder and spend more time to fix the Export Machine. Make in India is a good step but cannot be the only one. At a second level, both the PM and FM must reconsider their current support levels for the household sector. Perhaps, a slight shift from Infrastructure spending to Households (via lower Taxes) would ensure a wider group of Sectors are benefitting than currently. That might spur the economy immediately. In the meanwhile, we all hope that GST and post-monsoon will boost the economy significantly.

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