Economy in free fall: Govt is killing growth, not Greece

Don’t blame Greece anymore. We did this all on our own. Thanks to a mixture of policy paralysis, political and economic mismanagement, and the inability of Pranab Mukherjee to manage credible budget numbers, the economy is into a free fall.

The government’s estimates of gross domestic product (GDP) in the last quarter (Q4) of 2011-12, released on Thursday, came in at a shockingly low 5.3 percent, even while the figure for the whole year was reported at 6.5 percent (See full data here). At 6.5 percent, it is even lower than the Central Statistical Office’s advance estimates of 6.9 percent for the year released in February.

But it is the quarterly trends that tell the real story of an economy careening downhill with no sign that the brakes are working. In the first quarter of 2011-12 (April-June 2011), the GDP grew at 8 percent; we told ourselves it was only a matter of time before we get back to 9 percent; then it fell to 6.7 percent in Q2, and we consoled ourselves that 6.7 is nothing to sniff at when the world was going downhill; GDP growth fell further to 6.1 percent in Q3 and we said maybe the last quarter will see a pullback. Well, the last quarter - which is traditionally the busy period - has come and gone, and it shows growth is down to 5.3 percent.

The rout is seen in sector after sector - agriculture, and manufacturing both declined consistently in quarter after quarter last year, with the former coming down from 3.7 percent in Q1 to 1.7 percent in Q4, and the latter from 7.3 percent to -0.3 percent in Q4.

What’s holding up is financial services (up from 9.4 percent to 10 percent), and the big spike is in Community, social and personal services (from 3.2 percent to 7.1 percent).

What’s this wonder sector - Community, social and personal services? Well, the number includes government services. Government is bloating like never before. In a reviving economy, government should be shrinking to allow space for the private sector to grow.

That it is bloating means bad news. Figures for private and government consumption figures tell this story. While private final consumption expenditure shriveled from 59.5 percent of GDP in Q1 of 2011-12 to 52.2 percent in Q4, government expenditure swelled from 10.6 percent to 11.4 percent. In short, the Indian people are tightening their belts, and the government is swallowing the sacrifice in big gulps.

When government eats so much, it pushes up borrowing costs for everybody, and investment (gross fixed capital formation) shrank from 33.9 percent of GDP in Q1 to 30.9 percent in Q4.

The picture at the end of 2011-12 isn’t pretty: falling growth, bloating government, rising inflation, falling rupee.

Of course, we can wish away 2011-12’s dismal figures as a bad memory. But the downward push to business confidence and economic impulses will continue this year, too.

For several reasons.

First, in Q1 of 2011-12 (April0June), GDP grew at 8 percent. On that high base, given the continuing slowdown, Q1 in 2012-13 (the current quarter ending 30 June) will surely be weak. It could be worse than 5.3 percent. So prepare for another shock in August, when these numbers are out.

Second, energy prices have nowhere to go but up. Petrol has gone up, and diesel could be coming up next by end-June. But there is still a question-mark over the Congress party’s political will, given the brouhaha over petrol - which has less inflationary impact that diesel. When diesel happens, it will slow down growth in the second quarter, too. If it doesn’t happen, god help us. For government deficits will then become simply unmanageable, denting investor confidence and growth further.

Third, the most crucial number that will determine the GDP trajectory in 2012-13 is the value of the rupee: if the rupee stays where it is for most of the year (around Rs 53-56), our import costs will rise, and inflation will stay stuck at high levels. This means the Reserve Bank cannot easily cut rates.

Fourth, the global economy is in bad shape, not only due to Greece, but also because of concerns about the US, where growth may taper off. If this happens, capital flows to India will remain muted, and the rupee will stay down. But if global growth slows, it can cause commodity prices to fall - helping us with our oil import bills (as is happening now). Which is why we can’t blame Greece for all our ills. On the contrary, it may even help us with our import bills and inflation.

But the overall growth prognosis for 2012-13 - which the Reserve Bank optimistically projected at 7.3 percent in April when other analysts have been talking of 6-6.5 percent - is below par growth. We may have to be happy even with 6-6.5 percent. Or even below 6 percent.

But even this depends on government action, not Greece or global trends.

Consider this: even as growth has come down to 5.3 percent in Q4 last year, consumer price inflation is in double-digits, and wholesale price inflation is above 7 percent. In the short term, as fuel prices are adjusted, headline inflation will rise before it falls.

The fundamental problem in the Indian economy is the loss of global confidence in our medium-term future. This calls for reforms and hard decisions - which may push growth down, but will force a readjustment in the economy that will serve as seed capital for future growth.

The most important area for reform is obviously energy pricing. Last year’s oil losses were Rs 1,38,500 crore; this year could be in the range of Rs 1,50,000-1,80,000 crore, depending on oil price trends and how soon we raise diesel prices. If India starts steadily adjusting diesel and cooking gas prices to market levels, with subsidies being restricted only to a few sectors, the world will get the message that we are serious about fixing our problems.

The next important focus area is to get policies right - from spectrum allocation to aviation to automobiles to oil and coal - the government has to opt for transparency and market-pricing to improve efficiencies, competition and government revenues.

The third important area to fix is subsidies: from food to fertiliser to oil, the subsidy bill is simply too high. The finance minister has promised to bring it down to 2 percent of GDP this year, and further to 1.75 percent over three years. But he hasn’t even started doing this - though two months of the year are over.

The rupee will show spine only when the government does.

In the meanwhile, we have essentially kissed goodbye to our much-ballyhooed tryst with destiny in 2012-13, when we could have become a $2 trillion economy. The projected GDP (at current prices) of Rs 10,159,884 crore in 2012-13 is now a pipe dream, since 2011-12 GDP has printed at 8,232,652 crore. There is no way we can grow 23 percent in money terms this year - unless we let inflation rip (which one can’t rule out, if the policy paralysis continues).

In the budget, Pranab Mukherjee projected 14 percent growth at current prices, which means GDP at factor cost will be Rs 9,385,223 crore in 2012-13. If the rupee stays at 55, we will be a $1.7 trillion economy; if it falls to 50, we will be a $1.87 trillion economy.

If we had managed our economy well, and the rupee had remained at 45 to the dollar as in early 2011, we would have been a $2 trillion economy.

So, as we said, don’t blame Greece. It is we who killed our own growth story and our $2 trillion dream.