economic growth

India might grow by 30% early next year, but that won’t mean much.

छोड़ो कल की बातें, कल की बात पुरानी
नए दौर में लिखेंगे, मिल कर नई कहानी
हम हिंदुस्तानी, हम हिंदुस्तानी
— Prem Dhawan, Usha Khanna, Mukesh and Ram Mukherjee in Hum Hindustani. 

The Indian economy contracted by 7.5% during July to September 2020, in comparison with the same period in 2019.  When compared with a contraction of 23.9% during April to June 2020, a contraction of 7.5% looks significantly better.

Hence, there has been a lot of song and dance from the establishment and its supporters, on how quickly the Indian economy is recovering, especially when most economists expected the economy to contract by 10% during July to September and it contracted by only 7.5%. Terms like a V-shaped recovery have been bandied around a lot, over the last few weeks.

Nonetheless, India continues to remain in the bottom quartile, when it comes to economic growth/contraction of countries between July to September this year. Greece with an economic contraction of 11.7% is right at the bottom.

In fact, the song and dance of the establishment is likely to continue in the months to come and will reach its peak sometime in the second half of the next year, after the gross domestic product (GDP) figure for the period April to June 2021, is published. GDP is a measure of the economic size of a country.

It is worth remembering here that the GDP during the period April to June 2020 contracted by nearly a fourth. The GDP during the period was Rs 26.90 lakh crore. In comparison, the GDP during April to June 2019 was at Rs 35.35 lakh crore.

So, the GDP during April to June 2021, will grow at a pace which has never been seen before. If it comes in at Rs 30 lakh crore, the growth will be around 11.5%. Given that, the GDP during the period July to September 2020 was already at Rs 33.14 lakh crore, the GDP during April to June 2021, is likely to be higher than that.

At a GDP of Rs 35 lakh crore, the economic growth during April to June 2021 will come in at a whopping 30.1%. Nevertheless, this is just an impact of what economists like to call the low-base effect.

A central government which can use a contraction of 7.5% to market itself, imagine the possibilities of what it can do if the economic growth rate crosses 30% in the first quarter of the next financial year.

While, some song and dance can do no harm to the economy, the real story needs to be understood and told as well. The real GDP in April to June 2021 will be more or less where it was during April to June 2019. In that sense, we will be where we were two years back.

Hence, the economic slowdown which started in mid 2018, along with the contraction that has happened post the spread of the corona epidemic, has pushed the Indian economy back by at least two years. Obviously, this can’t be good news.

Other than talking, the central government hasn’t done much to get the Indian economy going. Between April and October 2020, the government spent a total of Rs 16.61 lakh crore. In comparison, it had spent Rs 16.55 lakh crore during the same period in 2019. The difference being, this year we are in the midst of an economic contraction.

In a scenario where the corporates as well as individuals are going slow on spending money, government spending becomes of utmost importance. Between March 27 and November 20, the non-food credit of banks has gone up just Rs 26,496 crore.

Banks give loans to the Food Corporation of India and other state procurement agencies to buy rice and wheat, directly from the farmers. Once these loans are subtracted from the overall lending of banks what remains is non-food credit.

In comparison, the deposits of banks have gone up by Rs 8.03 lakh crore during the same period. This means just 3.3% of the fresh deposits that banks have got post March have been lent out.

What does this tell us? It tells us that both corporates and individuals are largely sitting tight and saving money. This is an indication of the lack of confidence in the near economic future. While the corporate executives might keep going gaga in the media about an economic revival, these numbers tell us a different story.

What hasn’t helped is the fact corporates have reported bumper profits by driving down their raw material costs, input costs and employee costs. This basically means that along with employees, the suppliers of corporates have also seen an income contraction. This can’t be good news for the overall economy.

The government’s inability to spend, comes from the lack of tax revenues, something that is bound to improve in 2021-22. Other than that, the government hasn’t gotten around to selling its stakes in public sector enterprises. Of the targeted Rs 2.1 lakh crore just 3% has been achieved. This is bizarre given that the stock market is at an all-time high-level.

Hopefully, the government will make up on this in the next financial year. Also, it can look at selling some of the land that it owns in prime localities in Indian cities.

All this can be used to put more money in the hands of consumers through an income tax cut and a goods and services tax cut, encouraging them to spend.

People who pay income tax may form a small part of the population but they are the ones who actually have some purchasing power. And once they start spending more, the chances of it boiling down the hierarchy are higher. Do remember, at the end of the day, one man’s spending is another man’s income.

A slightly different version of this piece appeared in the Deccan Herald on December 20, 2020.

The Curious Case of the Indian Festival Season

Summary: Does the Indian economy actually have a festival season when it comes to consumption? 

I recently did a long story for the Mint where I elaborated on why this festival season isn’t going to rescue the Indian economy.

One of the questions I originally wanted to explore in the piece was whether the so-called festival season actually has an impact on the overall economic growth or is it simply a marketing gimmick, like many other things. I couldn’t get into it for lack of space and hence, have decided to explore this separately here.

The festival season is defined as the period between October and December which typically has festivals like Dussehra, Diwali and Christmas, among other festivals. This is believed to be an auspicious period for making purchases, particularly the period between Navratri and Diwali.  Of course, there are many big festivals that do not happen during this three-month period, like Ganesh Chaturthi, Holi etc. (Even Dussehra can sometimes fall towards the end of September).

As a 2018 research note published by the rating agency Crisil points out: “Indeed, in the last ten years, around 30% of two-wheeler sales has come in the festive months.”  Over and above this, industry estimates suggest that 35-40% of sales of consumer durables in particular electronic products, happens during the festival season.

Hence, in the run-up to this period, corporates are typically very confident about how festival season sales will perk up the overall economy. And this year, as I explained in my Mint piece, has been no different on that front. This grandstanding has only increased over the last few years as the economy has gone downhill. The corporates need to say something positive to keep the media interested and this is what they come up with. Come festival season, and all will be well. Of course, I am making this a tad simplistic, but I hope you do get the drift.

There is a simple way of checking out whether the so-called festival season has a marked impact on economic growth and whether growth during these three months is higher than the growth during the remaining part of the year.
India started declaring quarterly gross domestic product (GDP) data from 1996 onwards. Hence, GDP growth data is available from April-June 1997, a year later. GDP is a measure of the economic size of a country.

Between April to June 1997 and April to June 2020, we have 93 counts of GDP growth data, with 23 counts of the October to December period. In three years out of the data for 23 years that we have, the economic growth has been the fastest during the October to December period, in comparison to the remaining parts of the year.

Also, the three instances where before 2011, in 2001, 2003 and 2010, when the economy during the period grew by 6.3%, 11.2% and 10.7%, respectively. So, clearly on the whole, there is no evidence to suggest that the economy grows faster during the so-called festival season vis a vis the remaining parts of the year. And there is nothing in the last decade.

While, the economy may not grow faster during the festival season, that is no reason to believe that the private consumption part of the economy doesn’t grow faster during this period than other periods.

One of the methods to calculate the GDP is private consumption expenditure plus government expenditure plus investment plus net exports (exports minus imports). Private consumption expenditure, the stuff you and I buy to keep our lives going, over the years has formed the biggest part of the GDP. Data from the last 24 years shows that it typically tends to oscillate between 55-60% of the economy. On rare occasions it goes above 60% or falls below 55% (as it has during the period April to June 2020).

There are seven instances in the growth data of 23 years that is available, where private consumption expenditure has grown faster during the festival season than other periods. Three of these instances are between December 1996 and December 2010 and four after that. What this means is that around 30% of the time in the last 23 years, the festival season consumption growth has been the fastest during the year.

While, this is better than overall growth, it is not definitive evidence. Let’s look at something specific like domestic two-wheeler sales and see if companies end up selling more two-wheelers during the festival season than any other time of the year.

We have quarterly two-wheeler data going as far back as April to June 1991, that is for a period of 29 years. In eight out of these 29 years, two-wheeler sales were the most during the festivals season than other parts of the year. This works out to 27.6%. The interesting thing is that the sales during the festival season were the highest in each of the years from 2002 to 2007. This makes for six out of the eight instances. There have been only two instances in the 2010s, in 2012 and in 2013, and no instance in the 1990s.

What more data can we check? Let’s look at domestic car sales. There are two instances (2015 and 2019) where cars during the festivals season have outsold the other periods, in the last 29 years. Clearly, cars don’t have a festival season.

Ideally, I would have liked to look at the data for electronic products (washing machines, phones, TVs, ACs, etc.) as well. But data for such products isn’t really publicly available.

From what is publicly available we can conclude that the evidence for there being a festival season for Indian consumption is at best weak. In fact, when it comes to car sales, evidence for many years suggests that most cars actually sell during the period January to March.

So, the question is why do corporates keep talking about festival season sales? In the past few years, as the economy has gone downhill, it is a good way to sell hope which the media and the people reading and watching the media, are desperately looking for. (For all you guys who keep asking we know the problems, give us the solutions, this is for you).

One sector which has used this strategy over and over again, over the years, is the real estate sector. Come August and you will start seeing the gurus of this sector telling the media that Diwali sales are going to perk up. But what has happened instead, at least over the last half a decade is that the number of unsold homes has gone up and at the same time the total amount of money that the real estate sector owes to the banks has gone up as well. Of course, it hasn’t defaulted as yet, primarily because the Reserve Bank of India has come to its rescue and changed regulations.

For the media the belief in the festival season makes sense because it tends to drive up advertisements which it badly needs.

To conclude, even if there are sectors that benefit because of the festive season, it doesn’t translate into overall consumption and economic growth, that much is a given. The reason for the same can lie in the fact that while people increase consumption of a few things, they cut down on consumption of other things to maintain a sense of balance. But that is just an explanation, I really have no evidence of the same.

PS: For all you marketing and economic researchers out there, this might be an interesting topic to explore, using a more robust methodology than what I have used here.

India’s Economic Growth and the Power of Compounding

discount-10

On August 2, 2016, I had talked about a bungalow on the posh Nepean Sea Road in Mumbai, being up for sale.

The bungalow was last sold in 1917, at a price of over Rs 1 lakh.  Further, similar properties in the vicinity in the recent past had been sold for Rs 400 crore, or so, The Times of India reported.

Essentially, something that was bought for around Rs 1 lakh, 99 years back, is now expected to be sold for around Rs 400 crore.

This works out to a return of 11.3 per cent per year.

How how much would have the bungalow been worth now in 2016, if the rate of return had been just 30 basis points lower, at 11 per cent per year? One basis point is one hundredth of a percentage.

Would like to take a guess, dear reader?

Rs 395 crore? Or Rs 375 crore? Or even lower than that?

In fact, the answer will surprise you.

At a return of 11 per cent per year, the bungalow would have been worth around Rs 306.9 crore, or almost Rs 93.1 crore lower.

This would mean that the bungalow would be worth 23.3 per cent lower in comparison to Rs 400 crore.

And how much would the bungalow be worth at a return of 10.5 per cent per year? Would you like to take a guess?

Actually let me not prolong the agony. At 10.5 per cent per year, the bungalow would have been worth around Rs 196.3 crore. This is less than half of Rs 400 crore. Hence, a fall in return of 80 basis points per year, wipes off the value by more than half, over a 99-year period.

And how much would the bungalow be worth at 10 per cent per year? Rs 125.3 crore. This is around 68.7 per cent lower than Rs 400 crore.

So what is the point I am trying to make here? This is what the power of compounding can do. Even a small difference in return over a long period of time can make a huge difference to the amount of corpus you end up accumulating.

Of course, a normal person who is trying to accumulate wealth does not invest over a 100-year time frame. And further, even if he or she did, there is no way of knowing in advance what strategy would work best, over such a longish period of time.

Nevertheless, this piece is not about which is the best investment strategy in the long run. It is about the fact that what applies to investment returns also applies to the economic growth rate. Even a small difference in the annual economic growth rate over a longish period of time, can have a huge impact on how a country eventually turns out to be.

As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “The ‘power of compound interest’ over long periods is such that even a small change in the growth rate of per capita income makes a big difference to eventual income per head.”

And how do things look for India? Where would it end by 2040 at different rates of economic growth? As Joshi writes: “At a growth rate of 3 per cent a year, income per head would double, and reach about the same level as China’s per capita income today. At a growth rate of 6 per cent a year, income per head would quadruple to a level around that enjoyed by Chile, Malaysia and Poland today. If income per head grew at 9 per cent a year, it would increase nearly eight-fold, and India would have a per capita income comparable to an average high-income country of today.”

The question is what will make India a prosperous country. How do we define prosperity? As Joshi writes: “At a first pass, it could be defined as the level of per capita income enjoyed by the lower rung of high-income countries today, with the rider that national income should be widely shared and even the poorest people should have decent standards of living. To reach the said goal, India would require high-quality per-capita growth of income of around 7 per cent a year for a period of twenty-four years, from 2016.”

 The trouble is that there is almost no track record of any country (except China) growing at a rapid rate of 7 per cent per year, for a very long period of time, which is what India needs to achieve if it has to be prosperous.

When it comes to superfast growth China grew by 8.1 per cent per year between 1977 and 2010. Only two other countries came anywhere near. As Lant Pritchett and Lawrence H. Summers write in a research paper titled Asiaphoria Meets Regression to the Mean: “There are essentially only two countries with episodes even close to China’s current duration. Taiwan had a growth episode from 1962 to 1994 of 6.8 per cent (decelerating to growth of 3.5 percent from 1994 to 2010). Korea had an episode from 1962 to 1982 followed by another acceleration in 1982 until 1991 when growth decelerated to 4.48 percent—a total of 29 years of super-rapid growth (>6 per cent)—followed by still rapid (>4 per cent) growth. So, China’s experience from 1977 to 2010 already holds the distinction of being the only instance, quite possibly in the history of mankind, but certainly in the data, with a sustained episode of super-rapid (> 6 per cent per annum) growth for more than 32 years.”

Hence, the odds are stacked against India. And it will mean the governments doing many things right in the years to come, if the country has to get anywhere near a sustained growth rate of 7 per cent or more, for a longish period of time.

The trouble though is that most policymakers seem to take a growth rate of 7 to 8 per cent as a given, in their calculations, even though history shows otherwise.

The column originally appeared in Vivek Kaul’s Diary on August 18, 2016

Why Governments Love Inflation

rupee

The Reserve Bank of India(RBI) governor Raghuram Rajan has often been accused of not cutting the repo rate fast enough and in the process hurting economic growth.

Repo rate is the interest rate at which RBI lends to banks. The hope is that once the RBI cuts the repo rate, banks will cut their lending rates as well. In the process people will borrow and spend and economic growth will return.

The Rajan led RBI started cutting the repo rate from January 2015 onwards. Between then and now it has cut the repo rate by 150 basis points, from 8 per cent to 6.5 per cent. One basis point is one hundredth of a percentage.

In June 2016, the rate of inflation as measured by consumer price index was at 5.77 per cent. The repo rate at 6.5 per cent is hardly high enough.  The gap between the repo rate and the rate of inflation is not even 100 basis points. As Rajan said recently: “This discussion keeps going on without any economic basis. You saw the CPI numbers just last week. 5.8 per cent is the CPI inflation, our policy rate is 6.5 per cent. So I am not sure where people say we
are behind the curve. You have to tell me that somehow inflation is very low for us to be seen as behind the curve. So, I don’t really pay attention to this kind of dialogue.”

Also, the rate of inflation in January 2015 was at 5.19%. Since then it has risen by 58 basis points to 5.77% in June 2016. During the same period, the repo rate has been cut by 150 basis points. So the RBI has cut the repo rate despite, the rate of inflation going up. Hence, the question is, how has it been slow in cutting the repo rate? People who make such arguments, typically do not look at numbers and say things for the sake of saying them.

The fact of the matter is that all governments love lower interest rates and inflation. One reason for this is that low interest rates and inflation can create some growth in the short-term. As I had explained in yesterday’s column quoting a February 2014 speech of Raghuram Rajan: “if lower rates generate higher demand and higher inflation, people may produce more believing that they are getting more revenues, not realizing that high inflation reduces what they can buy out of the revenues. Following the saying, “You can fool all the people some of the time”, bursts of inflation can generate growth for some time. Thus in the short run, the argument goes, higher inflation leads to higher growth.”

The trouble is that this inflation eventually catches up with growth. As Rajan said: “As the public gets used to the higher level of inflation, the only way to fool the public again is to generate yet higher inflation. The result is an inflationary spiral which creates tremendous costs for the public.”

Take a look at the following table.

YearInflation (in %)Economic Growth (in %)Fiscal Deficit as a % of GDP
2007-20086.29.322.54
2008-20099.16.725.99
2009-201012.378.596.46
2010-201110.458.914.8
2011-20128.396.695.73
2012-201310.444.474.85
2013-20149.684.744.43
    
  

In 2007-2008, things were going well for India. The gross domestic product(GDP) grew by 9.2 per cent. The fiscal deficit was at 2.54 per cent of GDP. The inflation was at 6.2 per cent. Then the financial crisis struck in 2008-2009. The government decided to tackle the slowdown in growth by increasing its expenditure. In the process the fiscal deficit went up as well. Fiscal deficit is the difference between what a government earns and what it spends.

The fiscal deficit reached 5.99 per cent of the GDP. Next two financial years the economic growth crossed 8.5 per cent. The rate of inflation also entered double digits. The extra expenditure did manage to create growth, but it also created inflation.

This ultimately caught up with economic growth. The economic growth fell to below 5% levels in 2012-2013 and 2013-2014.

Hence, high inflation ultimately caught up with growth. But it did create growth for two years and during that period the Manmohan Singh government looked good. In fact, if the Lok Sabha elections were around that period, the Congress led United Progressive Alliance would have done much better than it eventually did.

The larger point is that any government has only got a period of five years to show its performance and in that period it has to do whatever it takes. If that means turning on inflation to create growth, then so be it. The trouble is that once you get inflation going, it is very difficult to control, as we clearly saw between 2007-2008 and 2013-2014. But the lessons of that are still not appreciated.

In fact, there is another lesson to learn here. As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “The Indian state has systematically underestimated the prevalence and the cost of ‘government failure’. It often intervenes, arbitrarily or to correct supposed market failures, without any clear evidence that the market is failing, and so ends up damaging resource allocation and stifling business drive.”

While, inflation ultimately catches up with economic growth, it ends up helping the government in another way. The government finances its fiscal deficit by borrowing. When it borrows the absolute level of government debt goes up. Despite this, government debt expressed as a proportion of the gross domestic product, might come down, because the GDP in nominal terms is growing at a faster pace than the debt, due to high inflation.

As Joshi writes: “From 2008 onwards, fiscal consolidation [in fact, the government was spending more] was meagre but this did not stop the debt ratio falling from 80 per cent of GDP in 2008-2009 to 68 per cent in 2014-2015. This is because high inflation eroded the value of debt.”

Due to inflation, the nominal GDP (which is not adjusted for inflation like real GDP, and against which total debt is expressed) went up at a much faster pace than the total debt of the government. This led to government debt expressed as a proportion of GDP falling.

Given this, there is more than one reason for the government to love inflation.

The column originally appeared on July 20, 2016, in Vivek Kaul’s Diary on Equitymaster

China Unleashes Another Round of Easy Money

chinaIn 2015, China grew by 6.9%. This is the slowest the country has grown in more than two decades. For a country which has been used to growing in double digits for a very long time, an economic growth rate of 6.9% is very low. Further, there are many economists who believe that even the 6.9% number isn’t correct.

A recent report in the Wall Street Journal quotes, an economics professor Xu Dianqing, as saying “that China’s gross domestic product growth rate might just be between 4.3% and 5.2%”.

The Chinese manufacturing sector which makes up for 40.5% of the economy grew by 6% in 2015. Nevertheless, many underlying indicators like power generation, railway freight movements, steel, cement and iron output, paint a different picture. As the Wall Street Journal points out: “Of some 60 major industrial products, nearly half saw output contract in the January to November period, while railway cargo volume fell 11.9% for all of last year, according to official sources.” (Doesn’t this sound similar to what is happening in India as well?)

Given this, it is only fair to ask how did the Chinese manufacturing sector grow by 6% in 2015? And how did the overall economy grow by 6.9%?

The point being that China is not growing as fast as it was and not as fast as it claims it is. Of course, if economists outside the government can figure this out, the government obviously realises this. Nevertheless, like all governments they need to maintain a position of strength and try and revive a flagging economy.

In the world that we live in, economists and politicians have limited ideas on how to tackle an economy that is slowing down. The solution is to get people to borrow and spend more. In a country like China where the government controls large parts of the economy, it means encouraging banks to lend more.

And that is precisely what has happened. In January 2016, responding to the low economic growth in 2015, the Chinese banks gave out loans worth 2.5 trillion yuan or around $385 billion. This is “a new record for a single month!” point out Dr Jim Walker and Dr Justin Pyvis of Asianomics Macro.

To give you a sense of how big the lending number is, let’s compare it to what the scheduled commercial banks in India lent during a similar period. Between January 8 and February 5 2016, the Indian banks loaned out around Rs 72,580 crore or $10.6 billion, assuming that one dollar is worth Rs 68.7. The way RBI declares lending data of banks, it is not possible to figure out how much the banks lend during the course of any month and hence, I have picked up the nearest comparable period.

The Chinese banks lent around 36 times more than Indian banks during a similar period. Of course, the Chinese economy is bigger than India is one factor for this difference.

A number of explanations have been offered for this huge jump in Chinese lending.  One is the revival of the Chinese property sector. Further, with the yuan depreciating against the dollar in the recent past, many Chinese companies are replacing their dollar debt with yuan debt, in order to ensure that they don’t have to pay more yuan in order to repay their dollar loans in the future.

But these reasons clearly do not explain this huge jump in lending. Chinese banks are lending out so much money because the government wants them to increase their lending dramatically.

The idea, as always, is to get people to borrow and spend money, and companies to borrow and expand, and in the process hope to create faster economic growth. The trouble is that all this borrowing and spending will only add to the excess capacity that already exists in China.

As Satyajit Das writes in The Age of Stagnation: “It would take decades for China to absorb this excess capacity, which in many cases will become obsolete before it can be utilised. Yet China continues to add capacity to maintain growth.”

Further, the credit intensity or the amount of new debt needed to create additional economic activity has gone up in China, over the years. As Das writes: “The incremental capital-output ratio(ICOR), calculated as the annual investment divided by the annual increase in GDP, measures investment efficiency. China’s ICOR has more than doubled since the 1980s, reflecting the marginal nature of new investment. China now needs around $3-5 to generate $1 of additional economic growth; some economists put it even higher at $6-8. This is an increase from the $1-2 needed for each dollar of growth 8-10 years ago, consistent with declining investment returns.”

The point being that China now needs more and more money to create the same amount of growth. And this means the effectiveness of borrowing in creating economic growth has come down over the years. This also means that the chances of money that the banks are lending out now, not being returned, is higher now than it was in the past.

In fact, as Walker and Pyvis of Asianomics Macro point out: “The China Banking Regulatory Commission reported that official nonperforming loans had jumped 51% year to 1.3 trillion renminbi [yuan] by December, now greater than at the last peak in 2009. While small in terms of the total number of loans out there – the bad loan ratio increased from just 1.25% to 1.67% – it is the direction that is bothersome, particularly given the well-publicised concerns over the accuracy of the data (hint: NPLs are much higher than 1.67%).”

Further, the Reuters reports that the special mention loans (loans which could turn into bad loans or what we call stressed loans in India), rose by 37% in 2015. And bad loans and special mention loans together form around 5.5% of total lending by Chinese lending. Indeed, this is worrying.

This huge increase in lending will obviously push up the economic growth in the short-term. But in the long-term it can’t be possibly good for the economy, as it will only lead to the non-performing loans going up and creation of many useless assets which the country really does not require. The current jump in bad loans of banks happened because of the huge jump in bank lending that happened in 2009, after the current financial crisis started.

Whatever happens, in the short-term, the era of “easy money” seems to be continuing in China. And that can’t possibly be a good thing.

The column originally appeared on the Vivek Kaul’s Diary on February 22, 2016.