Q1 GDP Growth

Don’t read too much into the sharp fall in GDP…

The Q1 GDP number announced on August 31st came in sharply lower than the Reuters estimates of 6.6%. The GDP growth at 5.7% and the GVA growth at 5.6% for Q1 represented nearly a 200 bps fall from the corresponding quarter last year. This raises serious questions over the ability of the Indian economy to sustain its growth edge over China. It was only last year that India had overtaken China in terms of GDP growth. At 5.7%, the GDP growth appears to trail Chinese quarterly GDP growth by nearly 120 basis points. Let us understand this in greater detail…

Blame it on demonetization… 

Not surprisingly, demonetization became the fall guy for this slump in GDP. While it is true that demonetization did shrink the SME sector, the overall impact cannot be attributed purely to the demonetization effort. Agreed, that it did create a liquidity crunch, but that should have resolved once the remonetization effort was undertaken from January 2017 onwards. As per the RBI data, almost 100% of the notes with the public have come back and nearly 85% of that has been re-issued. If the growth pressure is visible despite that, we are probably missing the larger story. The pressure on GDP growth despite remonetization goes to prove that the Q1 GDP number actually hints at a larger structural problem. The short term reason can also be attributed to the introduction of GST in July.

How GST made an impact… 

The launch of the GST effective July 2017 marked a quantum shift in the way the indirect tax regime was administered in India. The first quarter specifically saw aggressive de-stocking across industries as manufacturers preferred to remain light on inventories ahead of the GST launch. If that was the case, then the impact should revert from the next quarter itself. With the GST Council committing to be more flexible on rates, that should not be a worry for manufacturers any longer!

Watch out for structural issues!

The truth is that there are 2 structural issues that are actually holding back growth and both pertain to the supply side. Firstly, real interest rates in India are unsustainably high. Real interest rate at over 4.50% is hardly the rate at which corporates can meaningfully borrow and invest productively. The RBI has to sit with the Finance Ministry and work out a pragmatic solution. Only then will credit off-take pick up. The second challenge is the strong rupee. The SME segment in India is the real feeder for the export sector in India. That is being constrained by a strong rupee which is leading to negative growth for SMEs. So, let us pause for a moment before dumping all the blame on demonetization. There are structural issues. Let us acknowledge them and address these on priority!  ©

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