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Posted by: Deepa Vasudevan on Mon, Sep 2nd, 2019

GDP growth At 5%: An Explainer

India’s GDP grew at a real rate of 5% in the first quarter of the current fiscal year (Apr-Jun 2019). This is the lowest quarterly growth rate in six years. The announcement was fairly shocking because the growth decline was much sharper than predicted (Pic 1). In fact, some experts have described this as an “Economic Emergency”, a catchy phrase that was quickly picked up by several media outlets. But is India really facing a growth crisis? To answer this, let us understand more about GDP and probe the data further.

 

 Pic 1: Quarterly Economic Growth

Source: CSO


What does 5% GDP growth mean?

GDP is a measure of economic progress. It can be measured in three ways. One method is to add up the values of goods and services produced by different sectors in the economy- say agriculture, industry, financial services, real estate etc. The second way is to look at GDP in terms of what is demanded, and simply add up the money that is spent in the economy to fulfil that demand. For example, spending on education, food, holidays, wages and salaries, military expenditure. The final method adds up all the incomes earned in the economy- everything from the daily wage of a cleaner to the salary of the President of India.  The Central Statistical Organization releases GDP based on the first two methods quarterly and annually. So that is the data we normally analyse in trying to understand GDP.

A 5% GDP growth means that the GDP in April-June 2019 grew by 5% over the GDP in April-June 2018. Quarterly GDP is usually compared to the GDP of the same quarter in the previous year (also called year-on-year growth). This is because each quarter has unique features that impact GDP differently. For instance, the Oct-Dec quarter typically sees a lot of household expenditure on clothes, food, jewellery, or appliances, as it is the festival and gift-giving season. The Jan-March quarter tends to see tighter government spending as the government tries to control expenses and reduce its deficit before the end of the financial year in March.  Economists call this “seasonality”; and they get rid of it by comparing a period (week/month/quarter/half year) over the same period in an earlier year.

Is 5% GDP growth good or bad?

That depends on the economy! Advanced economies grow at low rates (maximum 2% to 3%), while developing countries grow much faster (anything 4% and over).

This growth divergence can be explained with a simple example. Consider two students- A and D. A usually gets 90% in his exams, while D gets 40%. Suppose D decides to study hard and improves his score to 60%, while A raises his score to 92%. D has improved by 50%, while A has improved by 2% only! The reason is that D started from a low base, and has more scope for improvement, while A is already close to the maximum score. Now replace A and D by advanced and developing economies. Advanced countries grow at low and steady rates as they do not have much potential to grow faster. Developing economies- if supported by demography, policy and global scenarios- can grow enormously for many years before reaching their maximum limits.

 

 Pic 2: Cross country GDP Growth: Apr-June 2019

Source: CSO

 

As Pic 2 shows, India is growing much faster than advanced economies, as it should, but it lags developing countries like Vietnam, China, Indonesia, or Philippines. India obviously needs to fix its problems so that it can at least lead among developing nations. Remember, a 2.3% growth for the US is superb, but 5% for India is a very mediocre achievement.

So why did GDP grow by just 5%?

To understand the reasons behind the 5% growth, we start by examining sector-wise GDP. We compare the April-June 2019 GDP with the GDP in Apr-June 2018 to cover seasonality and to the GDP in Jan-Mar 2019 to capture the latest trend. As Pic 3 shows, with the exception of electricity, gas and water supply, no sector has grown faster over both comparison quarters. Three sectors were worse off in both comparisons: manufacturing, construction, and financial services and real estate. Manufacturing growth has collapsed to 0.6% (probably because of the decline in domestic and global demand, plus the continuing stress of GST on MSMEs). Construction first slowed down after demonetisation, and was further impacted by the drying up of funds from housing finance companies. The NBFC crisis of 2018 also directly impacted financial services and real estate. Together, these three sectors account for nearly half the value added in the economy. Not surprising then, that growth has fallen so sharply!

 

 Pic 3: Growth by Sector

Source: CSO

  

The story gets more nuanced on looking at demand and spending by households, corporates and the government. Of the four components of demand- personal consumption by households, spending by the government, exports, and fixed investment- the first three slowed down further in Apr-Jun 2019, while investment picked up slightly (Pic 4). Government spending is likely to remain subdued as the government is in a tight fiscal position.  Falling export growth reflects the decline in global growth and trade war uncertainties; it is a function of factors external to the economy.

 

 Pic 4: Components of Demand

Source: CSO


But the main concern is the fall in domestic consumption growth, because India has always been a consumption story. IKEA and Netflix and Amazon are in India because they are attracted by the purchasing power of its households. But households are not buying as many goods and services as they did before, as shown by several consumption indicators. Sales of automobiles have been falling for more than a year. A report on the FMCG sector by market research company Nielsen suggested that rural consumers have cut back on purchases of all items, including small low-value goods[1]. FMCG majors like Parle have publicly said that they may need to retrench labour, as sales of even the low-end Rs.5 packet of biscuits is falling.  Housing demand is weak, and most cities have large inventories of unsold residential properties.  Rural demand- the backbone of India’s consumption boom- has declined mainly because growth in real wages (both agricultural and non-farm occupations) in rural India has fallen significantly. Households have less incomes, so they are reluctant to spend.

Why should I worry about a slowdown in GDP?

Everyone is affected when GDP growth slows down, though the extent and timing of impact will vary. When households buy fewer goods and services, firms selling those items earn lower revenues. If the slowdown persists or becomes worse, firms may be forced to lay off workers and cut back production. This could result in higher unemployment, and lower household incomes. The number of poor people would increase. A prolonged slowdown would impact the poorest and the most vulnerable far more than the richer sections of society: for example, a construction labourer would suffer much more than a university professor in the event of a sharp downturn. The government would have to direct resources towards alleviating poverty (through loan waivers or handouts) rather than invest in building social and physical infrastructure. In time, this means the quality of life and living standards would become worse.

So is it really an economic emergency?

India has experienced many ups and downs in economic growth, at different stages of its economic evolution, and for various reasons.  Sometimes growth slows down due to deep rooted fundamental problems with the structure of the economy (structural reason); and sometimes it is due to a temporary distortion or disruption that clogs up activity (cyclical reason). Right now India faces both structural and cyclical blocks to growth. The fundamental challenges include creation of jobs for its large number of young people, the urgent need for investment and reform in agriculture, reform of labour laws, infrastructure improvement, and the need to improve rural wages.   These will require legal changes, plenty of capital, and political will power. The quick-fix solutions include recapitalization of banks, restoring credit and liquidity to NBFCs, simplifying GST further, and working towards better tax compliance. The government has recently announced some steps to improve bank credit, and more reforms are expected in the near future. If policy swiftly targets the cyclical problems, and then tackles the longer term issues, the 5% growth will not be an emergency, rather, it can be an excellent wake up call for the economy!



[1] Nielsen Quarterly Insights Survey, June 30, 2019

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