Is 6 percent the 'new normal' for India's GDP growth?

Is 6 percent the new normal for India’s GDP growth?Miserably, it feels like it. India’s GDP expanded by 6.1 percent in the quarter that ended in December, the slowest pace in nearly three years on the back of slowing business investments, high borrowing costs, high inflation and an uncertain global outlook.

Worse, no one expects a robust recovery any time soon, especially if the government doesn’t step on the accelerator on reforms.

Economic growth in the third-quarter was dragged down primarily by a decline in mining activity (down 3.1 percent), as well as a steep fall in manufacturing growth. (o.4 percent). The biggest star was the services sector, which accounted for nearly 82 percent of the growth in GDP, according to a Kotak report. Agriculture contributed merely 0.5 percent, while manufacturing contributed 0.1 percent.Construction added 0.6 percent to growth, the brokerage said.

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[caption id=“attachment_230670” align=“alignleft” width=“380” caption=“The slump in manufacturing was matched by a 1.2 percent decline in gross fixed capital formation”]  [/caption]

The slump in manufacturing was matched by a 1.2 percent decline in gross fixed capital formation, which represents the creation of productive assets by businesses, from a year ago.

That’s a definite red flag on the economy’s health. Even as consumption (ordinary consumer spending was up 6 percent from a year ago ) continues to rise, investments in capacity creation are declining, which further widen the gap between supply and demand and threaten to push prices higher in future.

It’s a problem that could spiral out of control if action is not taken soon. Over the past year, everyone from the Reserve Bank of India governor to private-sector economists have noted that the lack of adequate “supply side” measures to meet growing demand has been one of the primary reasons for prices in the economy remaining stubbornly high.

Yet, instead of tackling the problem, the government has made it worse with a bulging fiscal deficit (caused by high spending on subsidies and other non-productive spending and a shortfall in tax revenues) and policy paralysis.

No surprise then, that some brokerages like Morgan Stanley expect even the current quarter - January to March - to remain lacklustre. Led by a slump in manufacturing activity, “We expect GDP growth for the quarter ending March to be around 6.5 percent,” it noted. The brokerage even lowered its full-year growth estimate (for the financial year ending March 2012) to 6.8 percent from 7 percent.

Moody’s Analytics’ senior economist, Glen Levine, is even more pessimistic: he believes GDP growth could fall below 6 percent in the first half of 2012 before recovering in the second half, according to a Mint report.

In a recent interview to The Wall Street Journal, RBI Governor D Subbarao pointed out that the Indian economy could grow at a maximum of 7 percent without stoking inflation. In other words, if growth climbed above 7 percent, the RBI would most likely have to step in to rein in inflation by hiking interest rates.

The structure of the economy no longer supports non-inflationary growth beyond that level; the required infrastructure, agricultural and business capacities are simply not there.

Unless the government announces a Budget studded with reforms to boost business sentiment and revive capacity creation, we might have to get used to growth of below 7 percent.

India’s economy, in the past, has often been described as an ’elephant’. The elephant is now feeling its weight.