New government needs to boost infrastructure spending

The real year-on-year gross domestic product (GDP) rose 4.7 per cent, a softer pace than the previous quarter’s 4.8 per cent.

The decline in real GDP growth was unexpected as analysts predicted an year-on-year increase of 4.9 per cent. The deceleration in GDP was mainly due to a contraction in manufacturing, taking 40 basis points off real GDP growth compared to the previous quarter, a decline in mining and a slowdown in utilities, construction, accommodation, transport and communication sectors. The only sectors improving from the previous quarter were the financial and social services sectors.

The weakening of the industrial sector is primarily due to very slow investment activity. Investments contracted in the third quarter of fiscal year 2013-14 amid political stalemate ahead of the general elections that will take place between April and May 2014. Economic growth is expected to remain subdued at least until the elections conclude — even then, it would require a strong majority win in order to start seeing projects materializing months later. The short-term impact of a clear victory allowing a strong government would boost positive sentiment, translating into stronger domestic consumption.

Another important factor affecting domestic demand in the fiscal year 2014-15 will be inflation. The year-on-year prices have been rising around six per cent since early 2013. Although this pace is lower than the 7.5 per cent rate of 2012, inflation is still obstructing consumption growth and is subject to volatility.

Food prices, a major component of the wholesale price index (WPI), and an even larger component of the consumer price index (CPI) — the indicator the Reserve Bank of India (RBI) is now targeting — is significantly dependant on weather and infrastructure. The monsoon was good this season, suggesting a larger supply of agricultural goods and less pressure on prices. However, infrastructure is not expanding as fast as demand, and hence will continue to create inflationary pressures.

While energy prices will keep steadily rising as subsidies continue to be gradually reduced, core inflation is expected to remain subdued, mainly because of the economy’s lower than potential growth. Although these factors point to a relatively low and stable inflation rate, prices also depend on another significantly volatile element: the rupee. The RBI has intervened accordingly to stabilize the currency, but its current low rate and the receding global liquidity suggest that it will remain a source of inflation in fiscal year 2014-15. This could hamper domestic consumption regardless of the election outcome.

The real GDP is a measure of the economic output or of the size of the economy — adjusted for inflation or deflation. It is the sum of the values of all final goods and services produced by that country or region over a given time period. Real GDP is a measure that holds prices constant by using a given year’s value (the base date) for all items and services.

GDP can be measured in several ways. The Central Statistical Organisation of India, the government body responsible for national accounts data, publishes GDP by expenditure and sector output. Private consumption is a major component of the services-driven country, making it more domestic-oriented than the rest of Asia.

Prior to the crisis, from 2006 to 2008, real GDP used to grow at an average year-on-year rate of 9.5 per cent while year-on-year inflation was as low as 5.5 per cent. For the last two years, year-on-year real GDP grew on average 4.5 per cent, and annual inflation rose seven per cent on average. The lower growth environment is partly behind the rise in structural inflation, due to the lack of infrastructure development.

Likewise, inflation is also hampering economic growth through higher commodity and logistical prices. The root of the problem lies in the lack of infrastructure spending. This could be resolved by a clear win by any party in the upcoming elections, but the new government would have to seriously tackle the investment deadlocks in the country. If so, it will still take at least another twelve months before investments take off. Expect more sluggish growth and persistent inflation in fiscal year 2014-15. However, a clear outcome in the elections could result in a market rally as investors expect an improvement in the institutional and regulatory conditions.

The writer is an economist at Asiya Investments, an investment firm investing in Emerging Asia.