In recent days, we have seen economists taking sides and writing explanation/ rebuttal on Indian government’s new methodology of calculating GDP. While that arguably is a good debate to have, the bottom line is that changing methodology hasn’t changed the fortune for our lackluster GDP growth.
The government thought that reducing policy rates will do the trick; trigger higher spending (goods are cheaper and savings less attractive!). RBI refused to play ball for some time, worried over the inflationary pressures that it can trigger but ultimately heads rolled, and rates dropped.
Did it work?
RBI Policy rate vs. CPI (Consumer Price Index) inflation:
The inverse relation between policy rate and inflation comes out very clearly, albeit the speed of transmission will also have a role to play. So, it was ok for RBI to worry but I guess they won’t be splitting hairs unless CPI inflation goes above 4%.
Are we sure that RBI need not worry? Or even ordinary consumers need not worry? Let us drill a little deeper on the CPI a little more.
Food & Beverage has the maximum contribution to CPI and it has risen from deflation (negative growth) to over 2%. F&B impacts common people most as it pinches the very basic need of people. The worry increases further if one peeps into the F&B breakup. Vegetable (figures in bracket indicates weight) shows significant price escalation.
Miscellaneous is the 2nd biggest contributor in CPI and we should be happy that its growth rate has been dropping. But let us look at its main breakups.
Why did we show the above breakup? That is because Transport & Communication has highest contribution into ‘Miscellaneous’ and while it has been cooling down, what do you think will happen to it with Budget increasing excise duty and cess of fuel? Post budget, we have already seen increased petrol and diesel prices by ~ 2.5 INR per liter across metros. Now correlate, the below Diesel (brown line) and Petrol (green line) price trend below (from https://www.mypetrolprice.com/petrol-price-chart.aspx) with that of Transport & Comm trend shown in above breakup of CPI. So, we can safely predict an arrest of fall or even growth in “Miscellaneous” bucket of CPI.
We also need to take a note that Petrol & Diesel price hurts a much broader economy,including vegetable prices, prices of household goods (transport cost increases etc.). Summary is that inflation remains a looming threat for RBI and for ordinary consumers as well and recent budget may make it worse.
Now keeping inflation out of discussion for a second, let us look at how economy reacted to drop in policy rates. Did it have the necessary growth impact? Keynesian economists often refer to Phillis curve which suggests that with growth comes inflation. Hence can we assume that the rise in inflation indicate that we have touched the growth lever?
Since GDP growth rates are published quarterly while RBI releases monetary policy bi-monthly, we averaged out the policy rates for the quarter for an easier comparison. The rate cut started in Feb-2019 (Q4 FY1718) and the least we can say, that it was unable to arrest the fall in GDP growth rates. Since impact of change in rates may have a lag effect, we should wait for Q1FY1920 GDP which will probably get released by 31st Aug 2019.
Again, the devil is in details. We need to drill down GDP. It can be broken in two ways, either from GVA perspective or from expenditure perspective. Let us first look at the GVA growth rates.
Nearly all major sectors witnessed lower growth rates Q-o-Q, including for Q4 FY1819. That isn’t ideal. Many will argue that with rate cuts in Feb’2019 start, we should see greater impact coming in 1st quarter of FY1920. Truly indeed, that is what is reflected in the IIP data (Index of Industrial production). See April FY1920 data, up & rising for all sectors and that also significantly!
But then happiness is generally short lived. Or that is what latest PMI Manufacturing data reflects. After hitting high in April-2019, it again dropped significantly in May-2019. And services PMI, even shows for first time a contraction (below 50)! Here again we see that drop-in policy rates have not necessarily spurred growth.
Why is growth so eluding? Read here: https://in.investing.com/analysis/the-economic-stutter-200430829
MOSPI just released latest (May 2019) data for CPI and IIP and it resonates the prediction we made in our article above (http://www.mospi.gov.in/press-release).
MOSPI just released the new inflation figures. June 2019 CPI inflation stood at 3.18%, compared to 3.05% in May’2019, a rise we predicted in our analysis above.
Similarly, IIP for May 2019, shows a growth of 3.1% compared to 3.4% in April-2019. Manufacturing growth stood at 2.5%, lower than 2.8% registered in April-2019.
The article is personal opinion of the author. We thank the author for his kind permission to publish it here.