Friday, November 29, 2019

Indian economy continues to slow down

Indian economy continues to slowdown. The latest estimate of economic activities by the government shows that GVA growth was 4.3% in the second quarter (July-September 2019) of fiscal year 2019-20. GDP growth at producers’ prices was 4.5%, the lowest in the last 25 quarters (quarterly GDP grew by 4.3% in Q4 FY2013). In terms of GVA growth (basic prices), this is the lowest quarterly growth rate since the availability of quarterly data (2011-12 constant price series).

Growth in all sector slowed down compared to Q2 FY2019. Agricultural output is estimated to increase by 2.1%, much lower than 4.9% in Q2 FY2019 but slightly higher than in the first quarter. However, industrial output slumped the most. It is estimated to grow by just 0.5% in Q2 FY2020, far lower than 6.7% in the corresponding quarter in last fiscal. Similarly, services sector is estimated to grow by 6.8%, which is also lower than the previous quarters. 

Within industry sector, manufacturing output actually contracted. It is expected to grow at a negative 1% compared to 6.9% in Q2 FY2019. Mining and quarrying output is expected to grow by 0.1%, which is better than negative 2.2% growth in Q2 FY2019, but lower than 2.7% in Q1 FY2020. Construction is continuing to slowdown too with growth of just 3.3%, also lower than the growth rates in the corresponding quarter in previous fiscal years. Electricity, gas and water supply activities are also slowing down. 

Within services, all activities are nosediving expect for public administration and defense related services. 

If we look at expenditure side of GDP data (which is basically GVA plus taxes minus subsidies), then we will see a drastic fall in gross capital formation (basically investment). It consists of gross fixed capital formation, change in stock and valuables. Gross capital formation growth is expected to be just 0.5%, the lowest in the last 22 quarters. GFC contracted (negative growth of 4.9% in Q4 FY2014). There is an improvement in net exports because exports growth remained stable but imports growth decreased slightly. Private consumption growth is almost stable but public consumption growth is picking up, albeit slowly. Essentially, the 4.5% GDP growth (producers’ prices) attributable to slight pickup in consumption but a drastic slowdown in investment. 

So, whats happening? Consumption demand is still weak, domestic credit is tight (partly contributed by the mess in non banking financial institutions) and investment in construction & infrastructure is slacking, weak external demand is slowing down exports and manufacturing, and consumer as well as investor sentiment is not that great. Core industrial output is slumping. It appears the structural reforms such as GST, bankruptcy law and slashing of corporate taxes are not yielding results in the short term (and they are not expected to do so). What is needed right now is fiscal policy that stabilizes the economy and brings it up to the growth sustained in the past. This requires more and faster government spending in sectors that can give high return (infrastructure investment) or some kind of fiscal transfers in rural sector (agricultural households) or significant efficiency enhancement of public capital investment. This might help stimulate demand in the short-term. However, this risks increasing fiscal deficit. There is a trade off, and managing is both good economics and art of managing consumer and investor expectations. 

The RBI will most likely go for another round of rate cut.

Wednesday, November 6, 2019

Undershooting the macroeconomic targets

It was published in The Kathmandu Post, 21 October 2019. Related detailed blog post here.

For the last fiscal year, 2018-19, the government had targeted a gross domestic product (GDP) growth of 8 percent. During that time, it promised that Nepal would experience double-digit growth within a few years. The government claims that the economy is in far better shape than when it inherited it from the previous government, because of policies and effectiveness of government operations. By vowing to overhaul public spending capacity, investment regulations, and governance, it has set an even higher growth target (8.5 percent) for 2019-20.

The latest data released by the government and the central bank show that economic performance is actually far behind the stated targets. The government failed to achieve most of the macroeconomic goals set during the beginning of the fiscal year. It indicates underperformance relative to its unrealistic targets.

Worse than expected

The economy is expected to grow at 6.8 percent at basic prices (7.1 percent at market prices) in 2018-19, lower than the government’s target. The government is claiming that since this is the third consecutive year of growth being over 6 percent, the Nepali economy is in a solid footing with strong economic and institutional fundamentals. Unfortunately, the reality is a bit different. In a way, the last three growth episodes are idiosyncratic. In 2016-17, the growth rebound was essentially a base effect because of the rock bottom economic activity in the previous two years due to the 2015 earthquake and India’s trade blockade. In 2017-18, it was due to temporary fiscal stimulus related to post-earthquake reconstruction and elections that drastically increased demand for goods and services. In 2018-19, it was good agricultural harvest underpinned by a favourable monsoon, post-earthquake reconstruction related fiscal stimulus, and tourism and real estate activities. Surprisingly, industrial output has contracted (especially manufacturing activities), and foreign direct investment has declined. This is in contrast to the Oli-led administration’s grand promises, of building the right policy environment and promoting political stability, at investment and infrastructure summits.

Consistently lower actual GDP growth than what was projected during budget speeches indicates that the government is not keeping its promises at the policy and operational levels. Consider the case of poor budget execution. While presenting the 2018-19 budget, the finance minister argued that the government would be spending over 90 percent of the capital budget and avoid expenditure bunching in the last quarter of the fiscal year. In reality, actual capital spending was just three-fourths of budgeted capital spending and over 40 percent of it was either spent or settled in the last month. It shows that budget execution undershot the target, and there was no change in spending pattern, raising concerns over the quality of spending. Moreover, actual capital spending is projected to be 6.9 percent of GDP, which is actually lower than in 2017-18. This is also reflected in the expenditure side of GDP data, as a deceleration of public gross fixed capital investment (think of the setback in completing large infrastructure projects such as Melamchi and Upper Tamakoshi).

Revenue performance was also below the target. A revenue growth target of about 30 percent—a feat achieved just once in the last decade—was too ambitious in the first place. The finance minister had asserted that the government would achieve it (to finance increasing recurrent expenditure) by plugging in leakages, broadening the tax net and implementing administrative reforms. Unfortunately, the lower than expected GDP growth rate and a slowdown in imports, which is the source of over 45 percent of tax revenue, meant that revenue growth fell below 20 percent. Expenditure under-performance but less than expected revenue mobilisation means that fiscal deficit will remain at a high level.

On the monetary front, inflation averaged 4.6 percent, much lower than the targeted 6.5 percent but higher than 4.2 percent in 2017-18. Higher fuel prices, depreciation of the currency and strong consumer demand propped up the prices of goods and services. Meanwhile, the money supply in the economy and credit to the private sector were not only lower than in 2017-18, but they were also below the central bank’s target. Liquidity shortage, caused primarily due to aggressive credit growth relative to deposit growth, persisted and interests rose to even higher levels. This increased the cost of financing for the private sector. In fact, the interbank rate (the rate at which banks and financial institutions lend to each other) is at its highest level since the last financial crisis in the fiscal year 2011-12. The stock market is more volatile than ever.

On the external front, a lower rate of import growth compared to export growth and steady remittance inflows despite a decline in the number of outmigrants resulted in a narrower current account deficit. However, the balance of payments slipped into the negative territory, the first time in the last nine years. The decrease in net foreign direct investment partly contributed to this. Consequently, foreign exchange reserves were just enough to cover 7.8 months of import of goods and services, down from 9.4 months in 2017-18.

Change is required

The government has again set ambitious targets for 2019-20 without notable changes to its operational strategy and policy facilitation. The latest consensus GDP growth forecast is between 6 percent and 6.5 percent, much lower than the 8.5 percent target set by the government. Despite the unfavourable monsoon, strong services sector output (contributed by steady remittance inflows and high tourist arrivals ahead of Visit Nepal 2020) together with ongoing post-earthquake reconstruction will support growth of around 6 percent. Achieving growth rate higher than 6.5 percent will require the government to address structural issues related to land acquisition, environmental clearances, investment-friendly regulations, productivity-enhancing infrastructure, human resources and the efficacy of the usually lethargic bureaucracy. It is a race against time for the powerful government with a two-thirds majority in Parliament to address these structural bottlenecks.

Given the way the government is implementing the budget, it is unlikely that there will be a drastic change in capital spending absorption capacity and revenue mobilisation, leading to a wider fiscal deficit and a higher level of public debt. Furthermore, investors are not entirely convinced by the government’s band-aid approach to solving structural issues plaguing private investment. Most of the commercial deals in infrastructure these days are settled at the government-to-government level, bypassing the usual competitive procurement among private companies. Liquidity issues are far from being resolved, and interest rate volatility will continue. The external sector is also projected to deteriorate next year.

Against this backdrop, the likelihood of the government missing its own targets again is quite high. The existing way of formulating the budget and its execution, coordination with the various tiers of government, tinkering policies to resolve structural issues instead of overhauling decades-old laws and policies, and slow pace of bureaucracy (be it due to politicisation or sheer inability) are not going to result in a vibrant economy that can sustain a near double-digit growth rate.