GDP Blues: April-June (2012-13) Data Sums Up Economy's Woes

The year has begun according to expectations. GDP growth figures for the April-June quarter of 2012-13 – at 5.5%, measured on a year-on-year basis -- reveals that the slow growth trend thrown up by the final quarter of 2011-12 (at 5.3%) continues.

This is not entirely unexpected. In fact, many analysts had predicted the growth number close to the final number. For instance, Bloomberg and Reuters had predicted the growth number at 5.2% and 5.3% respectively. Rating agency ICRA had estimated 5.1% while Moody’s assessment clocked in at 5.2%. Some analysts have tweeted that at 5.5% Q1 GDP growth is actually better than expected.

However, there are a couple of issues that must be noted immediately. One, at this growth rate, India is no longer the second-fastest growing economy in the region. It now lags behind Indonesia and The Philippines, with Malaysia nipping at its heels. Niranjan Rajadhyaksha has a nice short piece on it in Mint (read here).

There are is another source of anxiety. Manufacturing growth during the quarter, measured on a year-on-year basis, comes in at a dismal 0.2%, continuing the trend from the previous quarters. So what really saved the economy seems to be a 10.9% growth in construction and 10.8% growth in the segment titled as “financing, insurance, real estate and business services”. This seems to be a bit of an anomaly: if construction grew by over 10%, then it must have consumed cement and steel. Yet, this does not reflect in the manufacturing numbers -- unless, of course, the construction industry was running down its accumulated inventory of raw materials. Also, steel and cement combined have a decent weight in the index for industrial production.

The pathetic manufacturing data pretty much reflects the slowdown tightening its grip on the economy. Given that 0.2% growth also means people consumed almost exactly as much as they consumed during April-June 2011, does it also reflect slowing down demand? Could be true, given that private consumption expenditure grew by only 4.7%. This is lower than the growth registered by consumption expenditure in the past few quarters, particularly 6.% in the immediately preceding quarter. After all, wasn't it the boast of policy wonks that the consumption story had kept the India story vibrant during the global slowdown? That engine of growth seems to be sputtering now.

The other engine of growth -- investment -- also throws up a depressing picture. Investment growth during Q1FY13 came in at a measly 0.7%. The Indian economy at this point seems like an aircraft with both its engines seizing up.

So, where is this 5.5% impetus coming from? Consumption of services? Perhaps, especially because of money distributed by the government in the form of social sector hand-outs. The segment “community, social and personal services”, which captures these payouts (or considered an euphemism for all kinds of social sector hand-outs), grew by almost 8%. The government’s own expenditure – under the head “government final consumption expenditure” – has also grown 9%.

This pretty much sums up the problem facing the economy: largesse distributed by the government is distorting income levels, creating a spike in aggregate demand without an accompanying boost in investment activity (or creation of sustainable assets). This, in turn, is leading to a situation of low growth and high inflation.

Rating agency Crisil has come up with two interesting reports, one of which states that rural consumption now out-strips urban consumption. This outcome is primarily a consequence of money doled out in the rural areas by the government, described by some economists as money thrown from a helicopter.

But, that still leaves many unanswered questions in this puzzle -- for instance, if the rural consumption story is really so strong, and growing apace, why isn't manufacturing responding by increasing capacity? Is it being discouraged by the current policy paralysis? Or, are expectations playing a major role: that this rural story may not be a secular trend and might peter out soon? Or, expectations that interest rates might not soften in the near future? Methinks it's a combination of all the three expectations.

Inflation Eases, But Don't Dream Yet

The inflation figures for July, released today (Tuesday, August 14, 2012), paint a confusing picture. Overall inflation has relented a bit and comes in at 6.87%, measured on a year-on-year basis. This is lower than most expectations; various polls had estimated the figure close to 7.5%.  Last year, the inflation figure for July had come in at 9.36%.

So, what's brought the price levels down? Manufactured products actually, which have a weight of about 65% in the index. Prices in certain product categories -- such as "beverage, tobacco and tobacco products", "paper and paper products", "leather and leather products", cotton textiles -- are at the same level as last July.

That is a relief and the stock markets rallied immediately, in the hope that Reserve Bank will now have enough moral and economic fire-power to cut interests rates. 

However, that seems unlikely to happen so soon.

For one, RBI doesn't act on the basis of data for only one month. It has to be convinced that the rate of rising prices is slowing down on a secular basis.

But, more importantly, there are some bugs and time-bombs hidden away in the data. For instance, food inflation is up to 10%, compared to 8.2% in July 2011. Now, that's a source of worry -- given the reluctant monsoons this year, food prices have the potential of ratcheting up further.

Look at what's bumping up food prices. Potato (yes, that most humble of vegetables) prices have jumped 73% in July compared to the prices prevailing in July 2011. In fact, potato prices have almost doubled since March 2012! Prices of vegetables on the whole are playing havoc -- prices are up 24%! 

Even the protein sector is looking scary: pulses are up 28%, while prices of  eggs, meats and fish together are up 28%. 

Therefore, this current dip in prices may not bring the kind of succour that people were expecting. 

You Say Off-Shoring, I Say Outsourcing-I

And now comes news about the US authorities cracking down on Standard Chartered for allegedly side-stepping rules that prohibited dollar dealings with Iran or Iranian entities. The crack-down on StanChart raises many questions, leaves many issues unanswered.

For one, as already mentioned in the first instalment of this series, this recent development involving StanChart could be another example of the lax rules that get built into an off-shore risk and compliance centre. The reason for building a global risk and compliance centre in India is to primarily save costs, and not to tap into the fabled Indian talent pool. So, it could be India today and god-knows-where tomorrow.

However, as more news of the StanChart saga emerges, it seems there's more to it than meets the eye. Here are some conjectures.

1. This is another example of bullying and interference that has gained US so much notoriety over the past one century. It’s the with-me-or-against-me syndrome. In fact, when StanC’s US director warned the London office about the regulatory risks involved in dealing with Iran, one senior chap went apoplectic. You can read his outburst here, though there is no confirmation whether this really was the guy or not.

2. This is eager beaver Benjamin Lawsky trying to prove his credentials. He is Superintendent of the New York State Department of Financial Services, an office that has been created recently and he wants to demonstrate that he has what it takes. Read his profile here.

3. There is a suspicion that all this could part of an orchestrated political manoeuvre, with an eye to the upcoming presidential elections a few months later. Democrat nominee Barack Obama has been vocal about jobs being “exported” to India; and now, in a remarkable coincidence, you have examples of offshore centres in India coming across as fast and loose with rules, or lax and plaint. But, as I said earlier, this is just a coincidence, random speculation and there’s nothing to prove the claim.

4. It could also be a fall-out of USA vs Britain. According to The Economist, British politicians are “...accusing US regulators of pursuing an anti-London agenda following recent investigations into HSBC and Barclays.” Read The Economist story here.

5. Finally, the root of the problem is the dollar’s status as reserve currency. As long as that is reality, dollar transaction will need to get cleared in New York and thus will come under the regulatory glare of the US authorities. Iran had once proposed that it wanted to shift its international payments system to the euro. But, given the state of the euro and widespread apprehensions of its imminent collapse, the dollar remains the default reserve currency. Time for the yuan to stand up?

Blind-Sided By A Rate Cut

In the frenzied build-up to the Reserve Bank's mid-quarter policy review on July 31 and the drumming up of expectations about a rate cut, everybody took their eyes off the other niggling problem looming in the distance -- slowing down deposits growth.

As a result, while the Reserve Bank governor's policy statement on July 31 contained some nuanced messages -- in keeping with the hallowed tradition of subtle, implicit messaging from the central bank -- most of the public read the message only literally.

So next day, predictably, everybody voiced their disappointment at the absence of a rate cut and expressed their surprise at the SLR cut. This was my piece in next day's ET (read here) highlighting some of the cues in the policy document.

But, two days after the policy, this article by Sugata Ghosh (read here) in ET really spelt out the problem, at which I had only hinted and which the Reserve Bank governor tackled without triggering off any alarm bells.

It may be instructive for market participants to get over their obsession with interest rate cuts and try to see the big picture once in a while. In the absence of any credible policy action, a rate cut seems to have become the default solution. The bitter truth is that there are no magic bullets left for the country's economic problems.