MacroScan - Signs of Stagflation

Growth in India is slowing, even as inflation remains stubbornly high. According to recently released figures, GDP growth during the first quarter of 2008-9 stood at 7.9 per cent, down from the 9.2 per cent rate of growth registered in the corresponding quarter of the previous financial year. India, some fear, may have crossed a turning point, with growth in the future likely to be below the creditable 9 per cent per annum trajectory achieved over the last five years. But, it could be argued that a single quarter is no indication of what could happen over even this financial year, let alone over a longer period. In fact, over the last five years there has been one (2004-05) when the rate of growth fell to 7.5 per cent, only to bounce back the next year. So the prospect of a long-term trend rate of growth of 9 per cent may not have eroded as yet.

However, there are a number of features of growth performance during the first quarter that give cause for such concern. To start with, among the sectors that have lost their momentum is agriculture. This is of significance because advocates of reform have been arguing that over the last three to four years, the long-term, post-reform tendency for agricultural growth to lag behind industry and services has been reversed. If that was true, it is indeed an important development, because one factor that was taking the sheen off the higher growth of the 1990s and after was the extreme disproportionality in growth between the agricultural and non-agricultural sectors. The disparity in the rate of growth of agricultural and non-agricultural GDP increased significantly after the 1970s, with the process being particularly marked after the mid-1990s.
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However, figures on trends in crop production do not unequivocally support such a view. To start with, in the case of all important crops, rates of growth in individual years have been extremely volatile, with high growth occurring in particular commodities in very different years. The rate of growth of rice stood at -6.1 per cent in 2004-05, 10.5 per cent in 2005-06, 1.7 per cent in 2006-07 and 3.21 per cent in 2007-08. The corresponding figures for wheat were -5.0, 1.1, 9.2 and 3.4. Volatility was particularly marked in coarse cereals (-10.9, 1.8, -0.6 and 20.1) and oilseeds (-3.2, 14.8, -13.2 and 18.5). The only consistent and good performer was cotton with rates of growth of 19.7, 12.8, 22.2 and 14.2 per cent in each of these four years.

As a result of this volatility, a second feature of recent agricultural growth performance was that the average increase in production over the period 2003-04 to 2007-08 was low for almost all important crops excepting sugarcane and cotton. Finally, the revival in agricultural production holds largely for a few non-foodgrain crops, especially cotton and sugarcane, and not in foodgrains, which is one area where the recent inflation in prices occurred. Thus, the “agricultural revival”, as reflected in the figures on growth in agricultural production was at best partial, and did not correct the fundamental weakness that has characterised post-reform growth in India.

The evidence that supported the view that the differential between agricultural and non-agricultural growth rates was being redressed was the rate of growth of GDP in Agriculture and Allied Activities. While the rate of growth of GDP in this sector was just 2.9 per cent over the period 2000-01 to 2007-08 as a whole, it stood at 5.9, 3.8 and 4.5 per cent respectively over the three years ending 2007-08. Hence, the new evidence that on a first quarter to first quarter basis agricultural growth has fallen from 4.4 to 3.0 per cent, is indeed disconcerting, especially because of news that the monsoon this year has not been all too munificent in many parts of the country.

The second feature of the first quarter 2008-09 GDP figures that gives cause for concern is the fact that manufacturing growth has slowed substantially from 10.9 per cent in the first quarter of 2007-08 to just 5.6 per cent during April to June of this financial year. An aspect of the high growth in recent years was that unlike during the second half of the 1990s and the early 1990s, the sector that contributed significantly to the growth transition was manufacturing, which had recorded a sharp acceleration in annual rates of growth after 2003. It had also registered a significant and consistent increase in its contribution to the quarter-on-quarter annual increment in GDP. This less-recognized aspect of the growth story signified a shift away from the excessive dependence on services to generate increases in India’s GDP growth. What we have now are signs of a possible reversal of this tendency.

Third, there is reason to believe that the Construction sector, which had experienced significant acceleration in its contribution to GDP from 7.7 to 11.4 per cent of GDP between the first quarters of 2007-08 and 2008-09, is losing its dynamism in recent times. Not only do reports indicate that property prices and activity in the property market are subdued, but credit to the housing sector is drying up. Personal loans to the housing sector, which grew by 25 per cent in 2007-08, registered a much lower increase of 10.7 per cent last year. And the increase in lending to the real estate sector fell from 69 per cent to 38 per cent.

Finally, the evidence suggests that growth has once again come to depend on an expansion of services, with Services GDP growing faster than aggregate GDP. But here too growth has been decelerating in most areas. A disaggregated analysis suggests that there is only one component of the services sector—Community Social and Personal Services—that appears to have registered an acceleration in GDP growth.. On the other hand, the rate of growth of the other important segments of services— Financing, Insurance, Real Estate and Business Services and Trade, Hotels, Transport and Communications—which were important players in the aggregate growth story of recent years and incorporate most of the so-called “modern services”, have shown signs of deceleration.

Put all this together and the picture is by no means comforting. Especially since this slowdown, with signs indicating that it could persist, occurs in the context of sharp inflation exceeding 12 per cent on an annualised basis. Food articles are important contributors to this high inflation rate. Since agricultural growth appears to be slowing as well, this buoyancy in prices is likely to continue. The observed ability of the system to manage the effects of the difference between agricultural and non-agricultural growth is clearly now weakening, presaging a long episode of slow growth and inflation, or stagflation.

It is in this background that we need to assess the likely consequences of the implementation of the Pay Commission’s recommendations, including the payment of 40 per cent of the arrears that would give government servants a windfall gain. Inasmuch as that gain would result in increased expenditure and demand it would have the salutary effect of spurring growth. But inasmuch as the increased demand occurs in a context where prices are already rising and agricultural supplies are constrained it is bound to spur inflation as well. It is, therefore, likely that a government faced with a series of state elections that culminate in a national election next year, would look to the foreign exchange reserves the country has to resort to imports to hold the price line. That may not be good for the long run viability of domestic production, especially in the agricultural sector. But what matters in practice is what is good for the UPA, not what is good for the country.
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