Expenditure cuts necessitated by slowing revenue growth, weak industrial activity worrisome portents
The unexpected contraction in manufacturing in October raises concerns about the durability of the nascent economic recovery. While October’s estimate may turn out to be a blip, economists expect the growth in gross domestic product or GDP to slow further in the coming quarters. In the first half of the year, agriculture grew at 3.5 per cent, contributing roughly 0.4 percentage points to GDP growth. But this high growth was in sharp contrast to expectations of the sector growing at around one per cent for the entire financial year.
Notwithstanding a revision in numbers,according to Madan Sabnavis, chief economist at CARE, a probable explanation for the variance in forecasts and actual numbers is that “higher growth in the allied agricultural activities segment could have pushed up overall agricultural growth”.
Pronab Sen, former chief statistician of India, concurs. “Allied agricultural activities such as fishery and animal husbandry are now a much larger part of the agricultural sector, which could be why agricultural growth forecasts that rely only on crop data could have underestimated agricultural growth”, he adds.
The effect of the below-par and regionally skewed monsoon is likely to reflect in agricultural growth in the coming quarters. According to Sen, “The first quarter captures production figures of the previous rabi season, while the second quarter captures the sowing of the kharif crop. Actual production figures for the current agricultural season will reflect in the third and the fourth quarters, which is where the effect of the sub-par monsoon will show”.
With rabi sowing currently less than the same period last year coupled with a good harvest last year which would translate to a high base and with advance estimates showing a lower kharif output compared to last year, agricultural growth is expected to be lower in the coming quarters.
While Sabnavis expects “agricultural growth to be negative in the third quarter and lower in the fourth quarter compared to the last year”, Sen expects overall growth for the sector to be around two per cent for the entire financial year. Slower growth in the second half of the year is likely to reduce agriculture’s contribution to GDP growth by half.
Industry which accounted for 26 per cent of GDP in the first half of the year, continues to be volatile. Within industry, mining, manufacturing and electricity grew at 2, 1.8 and 9.5 per cent, respectively, in the first half of the current fiscal. But in the month of October, the index of industrial production or IIP contracted 4.2 per cent, solely due to manufacturing, which declined by 7.6 per cent. That this fall was over and above a manufacturing contraction of 1.3 per cent in October 2013 is a worrying sign.
But economists argue that the contraction in October should not be a cause for alarm as key indicators suggest improved industrial performance in November. Production reported by Coal India Ltd (CIL) and electricity generation indicated by the Central Electrical Authority for November show double-digit year-on-year growth. Automobile production expanded by 12 per cent and non-oil merchandise exports also rose by an estimated 13 per cent in November.
Further, two leading indices of economic activity, HSBC’s manufacturing Purchasing Managers’ Index (PMI) and the Reserve Bank of India’s Business Expectations Index, show an improvement in November and the third quarter, respectively, which does suggest higher industrial activity in the present quarter. Sen concurs, adding “the contraction in manufacturing in October is likely to be a blip as the there were many holidays in the month, which would have impacted production”.
While these indicators suggest better industrial growth, doubts remain. Though the HSBC PMI rose to 53.3 in the month of November, the survey suggests the consumer goods segment was the best performing of the broad areas monitored. This is in sharp contrast to the IIP data, which shows the consumer goods segment actually contracted in 10 of the last 11 months, with the biggest decline in the consumer durables segment, which contracted in 21 of the last 22 months. With the segment contracting 35 per cent in October, despite it being the traditional festive season, it suggests that demand continues to remain sluggish.
The capital goods sector continues to contract, reflecting sustained weakness in investment demand. According to the RBI’s survey, capacity utilisation is down to 70.2 per cent in the first quarter of 2014-15 from 77.7 per cent in first quarter of 2011-12. This suggests that even if demand rises it could be met by raising capacity, which indicates limited interest in launching new investment. As a consequence, bank credit offtake continues to remain weak.
Further, while automobile production expanded by 12 per cent in November, part of this rise could be due to the base effect as production had contracted by 8.2 per cent in November 2013. The cement and steel industries, which would be indicative of a revival in construction, also showed weak growth in October. Reflecting the volatility of the sector and these mixed trends, CARE expects overall industrial output to grow around 3 per cent in 2014-15, which is roughly the same as growth in the first quarter.
The services sector, which contributed roughly 4.3 percentage points to GDP growth in the first half of the year, is also expected to slow in the coming quarters. While financing, insurance, real estate and business services have been the only broad service sector category· that has registered strong growth consistently, HSBC’s Services PMI for the month of November reveals that contractions in activity were registered in financial intermediation, and hotels and restaurants.
Further, slower growth is also expected in the community, social and personal services sector. The sector, which largely connotes government spending, had contributed 1.3 percentage points to GDP growth in the first half of the year, but with government expenditure already reaching 90 per cent of its fiscal deficit target, and with tax revenues falling short of budget projections, spending is likely to lower in the coming quarters.
The recently released mid-year review by Ministry of Finance indicates a tax shortfall of Rs 1.05 lakh crore from budget estimation. This shortfall is higher than what Aditi Nayar, senior economist at ICRA, had earlier estimated. Based on the assumption that tax revenues would expand by 12 per cent in year-on-year terms in the last five months of this fiscal, Nayar had estimated the shortfall for the government relative to its budget estimate for net tax revenues could be Rs 75,000-80,000 crore (Rs 750 - Rs 800 billion).
The difference between the estimates suggests that the government is expecting tax revenues to grow at an even slower pace, which implies that further cuts in expenditure are likely. While the government has already announced a 10 per cent cut in non-Plan expenditure, cuts in Plan expenditure to meet the fiscal deficit target are also likely. According to Sen, “While it is difficult to estimate the exact quantum of cuts, it is likely that Plan expenditure will be cut in the coming months”.
Unless the government reverses its stance on fiscal policy, cuts in expenditure are likely to lower growth in the community, social and personal services category , dragging down overall growth of the services sector. Slower growth in agriculture and services will weigh down GDP growth. According to both CARE and ICRA, GDP growth in the third quarter is likely to be 5 per cent, lower than the second quarter growth of 5.3 per cent.
