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Is the Indian economy slowing down?
October 03, 2007
Do the recent IIP numbers foretell a slowdown in the economy? Or does one have to look elsewhere to seek the real picture?
"We could be standing at the edge of an economic precipice without really knowing it"
Yes, there are some signs of a slowdown in the economy and the risk of a more palpable downturn is building up. The mild slowdown in the economy that we see at the moment is best reflected in credit data.
Credit growth has slowed down from around 32 per cent (year-on-year) in July 2006 to around 23 per cent in August. Anecdotal evidence suggests that much of the deceleration in growth has come on the back of softer retail credit off-take.
Since retail borrowers do not have recourse to external borrowings, this must reflect a slowdown in underlying demand from the household sector. This would be for a whole range of things from housing to cars to white goods - in short, household purchases that were financed through bank loans.
The Index of Industrial Production has faithfully recorded this trend, with the "consumer durables" component recording dismal growth over the last few months. From whatever informal data that one can pick up on the housing sector, home sales have fallen sharply.
My apprehension is that developments in the global economy are likely to take a bigger toll on our economy than most of us anticipate. The contribution of exports to growth has increased sharply over the years.
If the US economy were to falter, taking the rest of the developed world down with it, the hit on the manufacturing and service sectors could hurt. Our estimate of the share of exports in the "manufacturing" component of GDP is as high as 60 per cent for 2007-08, up from 25 per cent in the early 1990s.
Manufactured exports are known to be sensitive to the vagaries of the US growth cycle as well as exchange rate movements. These sectors are also incidentally big employers and were they to slow down, the second round impact on employment and consumer demand might be significant.
The other key risk stems from the fact that the impact of interest rate increases on demand and growth persists for a fairly long period. Some studies, for instance, show that the sharpest impact of an increase in real interest rates on credit off-take is seen with a lag of as long as six to eight quarters. The implication is that the full impact of the sharp increase in lending rates at the beginning of this year is yet to be felt unless the rate cycle reverses quickly enough. The bottom-line is that we could be standing at the edge of an economic precipice without really knowing it. If we fail to recognise how precariously we are positioned, we might just keel over.
"A lower IIP number could be overshadowed by continued impetus from the service sector."
The recent July Index of Industrial Production (IIP) number clocking a modest below-expectation 7.1 per cent year-on-year growth has resulted in widespread concern about the sustainability of growth momentum.
To figure out how this might impact GDP, we need to delve a little deeper into the composition of India's GDP. We should note that the share of industrial production in GDP stands at only 20 per cent, while the service sector dominates with more than 60 per cent share. The relatively smaller share of industry in GDP estimation implies that a lower IIP number could be overshadowed by continued impetus from the service sector.
In the GDP calculations, construction activities are taken to be a part of services. Only manufacturing, mining and electricity components go into industrial production computation, with weightages of 80, 10 and 10 per cent, respectively. Another interesting thing to note will be the construction of the IIP per se. This is an index based on 1993-94 weights and does not entirely reflect the changing face of the Indian market. Interestingly, the weightage for milk powder is two and half times that of passenger cars and something as common as a personal computer, microwave oven, DVD player or laptop do not find mention in the list. There is a need for a revision of base year weights to capture the true dimension of India's growth pattern.
With only two months of soft industrial production data, we should hesitate to call this a secular downtrend. We are reminded of October 2006 when a sudden drop of the IIP growth rate to 4.4 per cent set off alarm bells only to be greeted by a 15 per cent-plus reading in the next month. Even in the periods of March-September FY06 and May-September FY07 we have witnessed yo-yoing of the IIP series, lessening our confidence to extrapolate from one dismal number. I wouldn't be surprised to see a better August; going by the signs of better automobile sales, better tax collections, better excise numbers, and improved coverage of kharif crops as reported by the ministry.
I am not saying there are no concerns. We cannot depend on demographics alone, as without opportunity demographics mean nothing. This apart, we need to continue the good work on rationalisation of the tax structure, reduction of parallel economy and enabling more free enterprise. Specifically, we need to foster equitable growth. But to conclude that there is a problem by looking at the IIP doesn't look right.
Overall, the story still looks strong and production and consumption structure of the economy is too intricately interwoven. To draw conclusions on the economy from one IIP number would suggest we think of it as fragile.