The May IIP (Index of Industrial Production) numbers came as a major disappointment after promising data logged in April. The numbers are at odds with May core sector data that showed a clear uptick (4.4 percent in May vs 0.4 percent in April) and thus proves that Indian economy is yet to comfortably come out of the slowdown phase.
Among the components of factory output, the one that should worry the government the most is the deceleration in capital goods segment to 1.8 percent in May, compared with 6.8 percent in April, which indicates that revival in investments isn’t happening as believed in April.
“This lends credence to the belief that presently these projects are isolated and confined to specific companies,” said rating agency CARE in a note last week.
What adds to the disappointment is the downward revision in April IIP numbers to 3.4 percent from 4.1 percent earlier. Also, if one strips out the benefit of base effect, the actual growth in IIP in May was just 1.8 percent. To sum up, the early signs of economic recovery aren’t sustaining yet as felt in April. The road to economic recovery remains not just bumpy but is filled with many potholes.
The pain points
The NDA government headed by Narendra Modi should take serious note of the growing disappointment on slow-paced reforms on critical areas — taxation and land acquisition. Global investors identify sluggish reform momentum as the greatest risk to India’s macroeconomic story.
The government’s flip-flop on the taxation policies can be “very very damaging” for Indian economy, Piyush Gupta, chief executive officer of DBS Bank said in Singapore last week addressing a group of journalists on the sidelines of Asian Insights Conference, 2015.
Lack of confidence in the government’s policies can impact investments especially in sectors where public private participation (PPP) model is key for revival, Gupta said. “PPP is all about the faith in the government. If you keep changing policies in six months or one year, how will they have the confidence,” Gupta asked.
Citing an investor survey, global rating agency Moody’s, last week said there is “some disappointment… with regard to the pace of reform under the administration of Prime Minister Narendra Modi, and increasing concerns about the risk of policy stagnation.”
The major hurdle for absence of pick-up in the economy remains painful absence of fresh investments, both from the private and public sectors. The government spending trend so far this fiscal has been disturbingly poor. Even in the first two months, the net increase in the government spending has been marginal.
Of the total spending of Rs 2.62 lakh crore (or 14.8 percent of the entire year estimates), the plan expenditure has gone up from Rs 59,609 crore to Rs 62,106 crore but the non-plan spending has declined to Rs 2 lakh crore from Rs 2.2 lakh crore.
Hence, the net increase in spending year-on-year in the first two months of fiscal year 2016 was about Rs 2,500 crore. On the other hand, the private sector investments too haven’t picked up and have been limited to specific projects.
Even though, there has been some decline in the number of stalled projects in the economy in proportion to the total number of projects, this has been partly due to abandoning of many projects and absence of new investments in projects.
Growth in bank credit, the potential trigger that can aid a faster turn around in the economic activities, has remained poor, which has beginning to impact the growth story, experts are pointing out.
“The declining momentum in credit growth is likely to have started impacting and this is leading to decreasing momentum in IIP growth,” said Soumya Kanti Ghosh, chief economic advisor, State Bank of India.
Bank credit growth on a year-on-year basis has continued to decline and was 9.8 percent as of 26 June, 2015, compared with 12.8 percent a year ago. There has been hardly any major incremental lending to industries and infrastructure in the recent years.
Indian banks’ helplessness to participate in the India growth story stems from their twin-troubles of high bad loans and capital scarcity. The stressed asset level on the book of state-run banks, which control 70 percent of the banking system, is at all-time high levels. Of the total Rs 300,000 crore non-performing assets of the banking system, over 90 percent is on the books of state-run banks.
Banks, burdened with huge bad debt on their books, do not want to take further credit exposure to riskier segments (read long-gestation infrastructure projects and construction activities) before cleaning up their book.
“The problem with private sector is not a rate problem… That problem rests with the bad loans in the banking system. Banks don’t want to lend to any private sector projects and the private sector entrepreneurs are not confident enough. The key to the private sector investments in India is to cut through the Goldilocks of this,” Gupta of DBS said.
After much persuasion from the RBI, the government has promised to rethink on the capitalisation programme for banks. But, Gupta is doubtful about the government’s ability to effectively handle this.
“That’s not easy. The problem with the Indian government is they don’t have the fiscal capacity to do this. Therefore to cut the goldilocks means only one thing. India has to privatise banks, which means they will have enough capital come in,” Gupta added.
If India is yet to come out of the shadows of slowdown, the NDA government is to be blamed on two fronts: One, for its lack of enthusiasm to cut stake in state-run banks and make capital available for banks to clean-up their books and resume lending activity. Second, for its inability to up public spending and push large-ticket reforms.
So far, the Modi government has scored poorly on these areas. The goldilocks solution to break the puzzle is kicking off banking sector reforms before it is too late.