Why India's economy won't bounce back in a hurry

Finance Ministry mandarins have dismissed the shocking estimate of 5 percent GDP growth for 2012-13 - the worst in a decade - put out by the Central Statistical Office on Thursday as not truly representative of the state of the economy, but the portents indicate that things will likely get worse before they can get better.

The 5 percent growth projection, arrived at by extrapolating data up to November, will almost surely be revised upwards in the second half. But even so, it doesn’t suggest in any way that the worst is over for the economy or that a bounce-back is imminent.

Given that the underlying data isn’t looking robust, it’s more likely that the recovery - even if it kicks in rightaway - will be slow and prolonged.

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The growth slowdown, which has rattled policy planners and industry alike, is of course worrisome in itself. But far worse is the implication it holds for India’s growth story over the medium term, since the principal driver of the 8-plus percent growth of recent years - investments - is coming off the rails. Indicatively, fixed investment grew at 2.5 percent in the months up to November.

In many ways, the sins of the past few years of profligacy - and failure to ensure investment in infrastructure - have caught up with the UPA government. An IMF report on Thursday noted that India was “paying the price” for failing to ensure that investment in infrastructure kept pace with GDP growth.

That has had a domino effect on the entire economy, and is reflected in the daily ordeal of power shutdowns and traffic gridlock, delays in establishing new projects, and in the slow pace of job-generation. Anecdotal evidence of the effect of this on consumption indicates that the ripple effect has been felt throughout the economy, and is reflected even in the slowdown in consumption growth rates to 4.1 percent, about half of what it was in 2011-12.

If all this sounds bad, worse may be in store. As Crisil Research notes, given that the investment pipeline is looking a bit weak, investment growth was expected to remain at low levels even during the next fiscal year. Even if the RBI continues to maintain a pro-growth monetary policy, and the government persists with its structural reforms programme to rein in the fiscal deficit, the pending issues in respect of land acquisition and mining would need to be sorted out for private investment to kick in.

The IMF concurs with that assessment. Citing the mass power cut last year as indicative of india’s infrastructure shortfalls, it reasons that addressing India’s long-term energy needs will require “solving complicated problems related to coal.” Easing traffic jams, on the other hand, will require facilitating the acquisition of land to widen roads or build new ones.

Not everyone, however, has a downbeat outlook on the Indian economy. Credit Suisse economist Robert Prior-Wandesforde says that beyond 2012-13 he expects GDP growth to improve as the effect of a drop in interest rates seeps in, and exports get a boost from the rupee depreciation of the past 18 months. And if the government’s reforms programmes - such as they are - boost investment and confidence, that could prop up growth going forward, he reckons.

But against this must be weighed the effect of Finance Minister P Chidambaram’s pledge to keep fiscal deficit to within the targeted 5.3 percent of GDP. Chidambaram has staked his reputation on that data point, telling foreign investors on his recent roadshow: “I have drawn the red lines: the fiscal deficit for the current year will be no more than 5.3 per cent and the fiscal deficit for the next year will be no more than 4.8 per cent.”

“I will not,” he pointedly emphasised, “breach that red line.” But that cannot be done without cutbacks to programmes, which in turn will have a knock-on impact on GDP growth, which in turn could upset his calculations for next year.

Already, economists cite evidence that suggests that seasonally adjusted data has been flat for the past three quarters ( more here).

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There’s nothing to suggest that there will be a sharp recovery in private investment growth, particularly as the government reins in spending to abide by its own ‘red lines’. The irony is that at precisely the point in time when the government perhaps needs to ramp up investments, it can ill-afford to, largely owing to the profligacy of the past.

All thing considered, even if the economy has bottomed out, after plumbing decadal lows in growth, it isn’t running away in a hurry anywhere. Get used to the new normal - of 5 to 6 percent growth or thereabouts.