India has serious economic growth problems

India’s official statisticians released the real 2017Q2 GDP growth number last week—5.7% over the equivalent quarter of the previous year. This was below the 6.5% consensus estimate of economists. India’s economy has been growing less and less healthy for awhile. GDP growth has now declined steadily for six straight quarters. This is a slowdown caused by factors deeper than the cash ban or any other temporary phenomenon. Something is broken in the Indian government’s policy mix.

Growth is unlikely to revive till it’s fixed. It’s true there might be a bit of a dead cat bounce in the medium term: For example, manufacturers who were running down inventories in anticipation of India’s new indirect tax regime, the goods and services tax or GST, might expand output a bit more. Imports might fall a bit as a consequence of subdued domestic demand.

But none of that will change the fact that government spending and low oil prices have deceptively boosted the growth numbers, masking the true state of the economy.

If public spending is excluded, growth in the past quarter barely topped 4%. Export growth is terrible and industrial growth is the lowest in five years. And the government will struggle to keep investing at these levels; it started spending big unusually early in India’s financial year, which starts in April, and has already run through 93% of its budgeted fiscal deficit.

Brent crude oil prices, which averaged $112 in 2012, had fallen to $52 by 2015. The International Monetary Fund, or IMF, calculated that the windfall gain for India on account of the fall in commodity prices was over 3% of GDP in 2015 and another 0.5% in 2016.

Future India Scenarios

1. The Bull case
India had setbacks due to demonetization and the introduction of the GST. Growth resumes at 8-9% per year.

2. Baby Bear case

There is no revival in investment demand. Commodity prices move up again. The banking system has trouble. The waiver of farm loans will stretch the resources of the states and the axe may fall on capital expenditure. The recovery is less certain, weaker and takes longer to arrive.

3. Big Bear case

India’s government takes the time to truly address crony capitalism and corruption. This results in near and mid term slower growth but would mean a stronger economy in the long term.

4. Extreme Bear case

The increasing capital intensity of manufacturing, automation and the backlash against globalization will all work against India. Global problems creating new jobs in the age of Artificial Intelligence and robotics hits India hard. Massive productivity, institutional and human capital improvements would be needed or low growth rates could be the new normal.

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