Latest IIP Numbers Add To Slowdown Woes: The Solution Lies In A Push For More Critical Reforms

Nearly everyone I spoke to, after the Index of Industrial Production (IIP) numbers for September were released, expressed concerns with respect to the extent of economic slowdown over the last couple of quarters. From a growth rate of 8 per cent, we are now thinking about a sub-5 per cent of growth in the second quarter.

Clearly, all is not well with the Indian economy.

Luckily, we have a government which is keen to make necessary policy interventions that can address different contours of the present slowdown.

Therefore, it must use this opportunity to push for some critically-important reforms that may be politically sensitive in nature. Finance Minister Nirmala Sitharaman has indicated the likelihood of some of these reforms as she hinted at the possibility of factor market reforms.

But before we discuss the policy prescriptions for addressing the slowdown, let us first understand the developments that have led us to this point and focus on the likely growth for the second quarter of the current financial year.

Regular readers are aware of my focus on real interest rates, which shot up before the non-banking financial company (NBFC) crisis. Incidentally, the slowdown worsened post the ILFS crisis. Therefore, a major part of the problem is monetary in nature.

The fact that repo rates have been reduced by 130 basis points may look like a significant monetary easing, however, inflation during the period has been lower and therefore, the real rates until September 2019 had reduced only marginally.

Moreover, the rate cuts are yet to be reflected to a great extent in prime lending rates. As is the case, the spreads of banks have widened, and this pose yet another challenge that needs to be addressed by the monetary authority. It is safe to say that despite a round of interventions from the North Block, we are still struggling with monetary challenges just as we were some months ago.

Clearly, Mint Street needs to wake up to the reality of an ever-widening output gap and immediate policy response needs to be prepared.

One critical question that is often asked, discussed and debated these days is with respect to the bottom of the cycle. That is, how low can growth fall before economic recovery begins. Regular readers may be aware of my hypothesis of economic recovery from the third quarter onwards.

We do know that automobile sales, especially private vehicles have shown signs of improvements and there are early signs of recovery of economic growth in the month of October. I am optimistic of recovery from the third quarter of the current financial year. But what is more concerning is with regards to the bottom of the cycle.

Three critical questions are, how low can this bottom be, the second is if there is a recovery, how quick it will be and the third is with respect to the duration of sustaining the positive business cycle once it emerges.

The answer to the first question is straightforward, growth in second quarter is likely to be the new bottom. This is further supported by the fact that we saw the worst IIP figures in the 2011 series for the month of September.

Though IIP captures a small set of manufacturing activity, however, it does act as an indicator of what is going on in the manufacturing sector. At a time when rural growth remains muted and IIP figures are sluggish, one finds little reason to assume growth to be above 5 per cent.

My initial forecast for first quarter growth was at 5-5.4 per cent while for second quarter it was at 5.2-5.6 per cent.

Clearly, first quarter was towards the lower end of the spectrum and consequently, I revised the forecast for second quarter to 4.8-5.2 per cent based on the then available set of data. Since then, government interventions have given me reasons to be a bit optimistic about the growth figures.

The implicit model behind the forecast also suggested growth to be at least 4.7 per cent. However, most analysts expected it to be at 4.5 per cent. Post the September IIP figures, they have revised downwards their forecasts to 4.2-4.3 per cent on an average.

However, even after incorporating the data for September IIP, the baseline model suggests 4.6 per cent to be the new bottom.

Consequently, the forecast is revised to 4.6-5 per cent, although growth is unlikely to be closer to 5 per cent in the second quarter. This implies that we are going to find out the answer to what will be the new bottom over the next couple of months.

The second question with respect to the pace of recovery depends on a wide range of issues. For starters, it depends on what happens to monetary policy in December.

Inflation has been muted and within the ‘4+-2 per cent’ range, and therefore, we should see aggressive rate cuts. We haven’t seen them so far and that maybe a reason why the output gap seems to have widened.

Clearly, Reserve Bank of India’s forecasts of future inflation and growth didn’t factor in such low estimates and this has become a major worry for many of us.

As far as the third question is concerned, unfortunately the answer to this depends on multiple factors such as what happens to our banking sector recovery, our NBFCs and more importantly, what is the outlook for global growth in the foreseeable future.

However, India does have a lot of low-hanging fruits to sustain and grow at above 7-8 per cent for the next decade and if there is any government that can ensure we achieve this then it is a government with a mandate of 303 with Narendra Modi at its helm of affairs.