Indian Economy Health Check

Global growth is being increasingly dependent on three countries with China, USA and India Contributing to 80% of growth in the first quarter of the calendar year

The global growth is increasingly becoming slower. Brazil and Russia are both expected to see their GDP fall in 2015.  It is left to only India and China to fuel the global growth engine with the help of the USA which is chugging along albeit not smoothly.

According to IMF:

Global GDP growth was sluggish in the first three months of 2015, remaining at 2.7% year on year for a second consecutive quarter. Growth in the world economy has become increasingly reliant on just three countries: China, the United States and India were responsible for nearly 80% of global growth in the first three months of the year. The euro area’s slow recovery has continued; the 19-country bloc experienced 1.1% year-on-year growth in the first quarter of 2015 compared with 0.9% in the previous quarter. Leaving aside China and India, emerging markets struggled in the first quarter. They contributed less than 13% of global growth, the smallest proportion since late 2009.

India is on a cusp of transitioning to a high growth phase

According to a World Bank report, India's GDP crossed the US$2-trillion mark in 2014 and at present stands at US$2.067 trillion. In just seven years, India has added one trillion to its economy.

Going by income, India is still in the lower middle income category. India's gross national income per person has risen to US$1,610, which converts to Rs 1,01,430 by present exchange rate.

The International Monetary Fund forecasted that India’s growth would strengthen from 7.2 per cent in 2014 to 7.5 per cent in both 2015 and 2016, overtaking China’s growth — for the first time since 1999 — that it projected will slow down to 6.8 per cent.

China is finding it difficult to avoid a hard landing if not a crash landing

China is finding it tough to revive the scorching growth rate that it had seen through the last three decades. China averaged economic expansion of around 10% a year over the past three decades, making it the world's second-largest economy and boosting household wealth. But now, the pace of growth is languishing -- China recorded GDP growth of 7.4% last year, the worst in 24 years; a significant slowdown from double-digit growth in 2010.

Investments have been going down and the government had been compelled to bring in monetary easing and pursue expansionary fiscal policy. However, there is semblance of stabilization but the effects of friendly monetary and fiscal policy is yet to have an impact on the economy in a previously.

The shocks are more visible than it was earlier it is causing concerns in the Chinese ranks.The week of 29^th June 2015 saw a meltdown of USD 2.8 trillion, a significant number by any account.  At least, 500 companies have stopped trading in the Shanghai and Shenzhen stock exchanges after the massive fall in their prices. The stock markets will rise, that is beyond any doubt. The question is whether the double digit growth will return. It my opinion, this will not happen in near future.

Downside risks stem from a sharp adjustment in the property market and limited local government spending. The concerns are real and the Chinese officials are rushing to stem the rot, otherwise this can prove to be a major downward spiral for China.

USA seems to be better placed than the last decade

The U.S. economy is growing moderately after a winter swoon and likely strong enough to support an interest rate increase by the end of the year, but concerns remain over the recovery of the labor market.

The OECD slashed its U.S. 2015 growth projection from 3.1% to 2%. If that comes to pass, it would be a dip from last year's 2.4% GDP. After a weak start to the year, highlighted by a first-quarter economic contraction, policymakers in the USA also said gross domestic product is poised to grow between 1.8 percent and 2.0 percent in 2015, down from a March forecast of between 2.3 percent and 2.7 percent.

Another key statistics that is used as a barometer to gauge the US economy is its labor data. In 2015, the domestic economy added 223,000 positions in June, according to a report released Thursday by the Bureau of Labor Statistics. And the June unemployment rate went down a fraction to 5.3 percent and even this was in part because a net 432,000 people left the domestic labor force. However, the labor force participation rate ticked down to 62.6 percent, its lowest level since October 1977.

Greek tragedy and lessons for India

Any economic analysis in the present scenario cannot be complete without discussing the situation in Greece. Government debt is 164% of its GDP and the country went loggerheads with the financiers and had to buckle down under pressure eventually and accept harsher austerity terms. The policies and stance taken by the Greece's Prime Minister Tsipras has driven the economy in downward spiral. The economy had started picking up in the last three quarters of 2014. However, with so much uncertainty prevailing currently and banks unable to provide the credit lifeline to businesses effectively, the Greek economy threatens to collapse.

The impact on India: Analysts claim that a Greek default has been factored in by the markets. That, perhaps, explains why the Indian equity markets did not crash on Monday. But aftershocks will linger, as the mood among the foreign funds will be rather subdued. In a bid to soften their losses on account of the prevailing situation in Eurozone and elsewhere, they can potentially pull out significantly from India -- or, at least, refrain from further exposures.

Raghuram Rajan, Governor of Reserve Bank of India, said that India's exposure to Greece was very, very limited. "The direct exposure is very limited for India. But there is some indirect exposure like how the Euro would react to the Greece situation." He added after the initial burst of volatility, investors will start differentiating. "Our growth prospects are good and the buffers that we have are reasonable, including foreign exchange," Rajan said.

Lessons for India- Apart from the almost unmanageable debt the other key reason for the problems in Greece is the low productivity of the working population. The GDP per hour worked per worker in Greece is one of the lowest at around USD 35, whereas in Luxemburg it is ~96 and for the USA it is ~67. The reasons could be traced to bloated government departments and expenditures, laws sanctioning more benefits without steps to ensure commensurate productivity increase, early retirement and pension pressure on government coffers.

Key Policy Recommendations for India:

Inflation should be monitored closely- Despite recent moderation in headline inflation, underlying inflationary pressures and upside risks remain. Monsoon, on which India’s food production is still dependent has been fluctuating raising concerns about inflation. Monetary policy should remain tight to reduce inflation and inflation expectations durably.

Fiscal consolidation should continue- Greece is a lesson in time for India. India should focus on the quality of the consolidation, underpinned by comprehensive tax reform (such as introducing the goods and services tax and improving tax administration) and measures to further reduce subsidies.

De-risking and recapitalization of banking sector should be pursued- To safeguard financial stability in the presence of rising corporate and banking sector strains, regulation should be further enhanced, provisioning increased, monitoring of corporate vulnerabilities strengthened (especially in light of large unhedged FX exposures), and debt recovery by banks further encouraged. Many of the banks especially medium sized public sector banks need to be recapitalized. Government needs to infuse as much as Rs 2.4 lakh crore (US$38.78 billion) into state-owned banks by end-March 2019 to meet different kinds of capital requirements including Basel III, provisioning for asset quality and additional risks

Currency volatility should be monitored- Should external pressures from global financial market volatility resurface, rupee flexibility is an important shock absorber, complemented by tightening of the monetary stance, with foreign exchange intervention limited to preventing excessive volatility.

Focus on labor productivity and equitable distribution of wealth- GDP of India went past USD 2 trillion and is expected to grow faster than it has done in the current decade. However, the growth needs to penetrate to the ground level. We need productivity to rise at the grass-root level. Education, Entrepreneurship and Innovation should be the buzzword for India. Its increase in per capita income and a favourable Gini index that India should be concentrating on.

Sources: IMF, OECD, Economic Times