The Switch To Recovery

Nine months into 2017, the wait for economic recovery continues. The current slowdown, with the GDP dipping to 5.7 per cent in the first quarter of fiscal year 2017-18, the lowest in three years, may have been exacerbated by demonetisation as well as teething problems attributed to the Goods and Services Tax (GST), but the economy had been slowing down well before these pol­icy decisions were put into effect. This was partly due to external as well as internal factors, including the impact of two years of drought in many parts of the country.

This monsoon, large parts of the country have seen heavy rainfall, res­ulting in severe floods that are expected to imp­act farm production, particularly foodgrains. With the government holding adequate stocks, food supplies are not a major concern. At this juncture, the slide in manufacturing growth from double digit in 2015-16 to the negative in the April-June quarter this year is particularly worrying as it has a direct bearing on job creation. This is of inc­reasing priority, given the job losses in the informal sector post demonetisation even as the pool of youngsters seeking jobs expands rapidly.

Prof N.R. Bhanumurthy of the Nat­ional Institute of Public Finance and Policy is optimistic that the worst is over. “In the first quarter, the impact of GST has bottomed out. We should exp­ect recovery now, but whether it is a sharp recovery or a moderate one, we will have to wait and see,” he says. With the costs of GST implementation and ambiguities surrounding it in terms of taxes and demand behind us, the manufacturing sector should recover. The bickering over the taxes may continue, but at least there is clarity on the overall cost of implementation.

“Now that the MSMEs (medium, small and micro enterprises) know the cost of implementation, they would be better prepared. Once they start getting their refunds, the working capital issues would be resolved,” says Bhanumurthy, clarifying that not just the MSMEs, but also those in the services sector have to pay for the input costs and later seek refund. “The cost to business may have increased in many cases as there may not have been any tax implications earlier. Obviously, those who were not paying any taxes earlier will say their costs have gone up. Also, we assume those who were paying tax were not evading any, which may not have been the case. But now under-reporting may not be possible.”

Jajit Bhattacharya, partner (strategy and operations) at KPMG India, is hop­eful that the Q3—a festive quarter that typically sees an increase in consumption (electrical appliances, jewellery, textiles etc)—will see growth returning as the disruptive impact of demon­etisation as well as the GST switch­over would also have waned.

Former chief statistician of India Dr Pronab Sen, however, feels that the impact of demonetisation and GST will take time to play itself out—maybe ano­ther two to three quarters. Another factor working against the manufacturing sector, according to Sen, is the rupee appreciation and the exchange rate. “The factors that are holding back growth—demonetisation, GST and rupee appreciation—will be around for a couple of quarters more at least. In manufacturing, it is a demand story, which continues to be weak. On the other hand, because of the rupee rise, imports, particularly in consumer goods, have gone up tremendously and the manufacturing sector is facing the consequences,” he says.

In India, the supply side is not the problem, unlike the demand side, which is why private sector investment in new projects or even capacity expansion is not picking up. Many economists share Sen’s views that the negative imp­act of demonetisation and GST will not wear out fast unless the government steps up public sector investments, particularly in the agriculture sector and rural infrastructure, and private investment picks up.

“Investment spending and consumption spending are areas of concern,” says Shashanka Bhide, director of the Mad­ras Institute of Development Studies. “The silver lining is that policies are in place to boost growth, but a good deal of uncertainty remains due to external and internal factors, so I don’t expect immediate pickup in the short term. It will take more time for policies like GST to have significant affect.”

The large MSME sector, in particular, has been hard hit in the past few years. Demonetisation together with the GST has further worsened the situation as “eight months post demonetisation, 20 per cent of the AIMO members have shut operations, while there has been 30 per cent rise in NPAs from the MSME sector,” says K.E. Raghunathan, national president of the All India Manufacturers Organi­sa­tion (AIMO). “The trade condition is such that most companies are not in a position to plan ahead.” AIMO fears the government proposal to make the fiscal year coincide with the calendar year will result in another chaos. “We have not seen the end of changes. Are we expected to run the ind­ustry or learn new ways of operating business?” wonders Raghunathan.

Anil Bhardwaj of the Federation of Indian Micro & Small and Medium Enterprises (FISME) says the outlook for the immediate future is “not optimistic. It is too early to speak about the mid or long term.” Bhardwaj stresses the need for transparency in the central government public procurement norms to help MSMEs. He also feels financial sector reforms to ease the stress on banks would help boost lending to industry.

Alongside the industry and trade bodies, the large farmers’ community too is reeling from adverse weather shocks and demonetisation. Compounding their woes are the falling prices. “If farmers’ protests went out of hand, they had a good reason to,” says Anil Adhikari, former head of agriculture commodities at Comtrade. For instance, wholesale inf­lation moderated sharply to 2.2 per cent year-on-year in May, compared to 3.9 per cent in March. This was significantly below expectations. Retail inflation fell to 2.2 per cent from a year ago in May 2017, a record low, as food prices—at -1.0 per cent—turned negative for the first time since 2001. Vegetables and pulses remained deflated at -13.4 per cent and -19.5 per cent. The negative price trend—prices dipping—continued.

“Remonetisation boosted growth in the cash-intensive services sectors, but this was offset by slower agriculture growth and a sharp slowdown in manufacturing gross-value added growth caused by production cuts ahead of the GST and lower profitability,” says Sonal Varma, economist with Nomura. Agricultural growth in real terms—that is farm GDP minus inflation—has slowed to 2.3 per cent from 5.2 per cent. “Despite real growth of 2.3 per cent, nominal agricultural growth was only 0.3 per cent, suggesting that while agricultural output grew, their prices fell,” says Dharmakirti Joshi, chief economist at Crisil.

The distress in agriculture caused by a fall in prices is more structural and not broad-based either across crops or states. For instance, prices of wheat and Bengal gram (chana) is steady, unlike green gram (moong), which has seen 30 per cent dip in prices. “This year’s near-average monsoon should help agricultural growth rebo­und,” says Joshi. As of August-end, total summer sowing was 3.3 per cent higher than last year and 5 per cent higher than the long-term normal levels. The impact of floods in several areas, however, has to be factored in.

In the short term, there are expectations of a pickup in sectors such as food and food products, textiles and intermediate construction raw materials, even as auto parts, machine parts and tools, among others, continue to struggle for growth. The growth expectation for 2017-18 so far remains pegged ­between 6.5 to 7 per cent.

By Lola Nayar and Zia Haq