Sobering news in the rear view mirror (with implications for the road ahead)
For market participants that are so focused on what the future holds, some pause was provided by historical data. GDP revisions of previous years revealed that FY13 (year ending March 2013) growth was reduced further from 5% (already a decade low) to 4.5%. To be sure this came on the back of an upward revision in FY12 but that, in turn, came on the back of a downward revision in FY11. Netting through all the revisions, the level of GDP output in FY13 was 0.4% lower than previously estimated, so the net impact was a downgrade on activity. The fact that core inflation remained elevated in FY13 when growth was tracking substantially below 5% is further confirmation to our thesis that potential growth has been moderating more sharply than presumed, and therefore output gaps may not be as negative as presumed.
And the reason for the falling potential was evident in the latest savings-investment profile. The aggregate investment rate fell off a whopping 1.7 percentage points of GDP in FY13 and is now at a seven year low. And the details were even more worrying. The corporate investment rate fell for a third straight year, is now at a decade low, and is almost half the level it was in the year before Lehman. Furthermore, the bulk of the reduction in aggregate investment continues to be in equipment investment, which embeds technological change and has direct implications for productivity growth.
Markets will focus on the markdown in headline GDP growth in FY13. And ironically that markdown creates a lower base, that could statistically inflate FY14 growth to 4.8-5% (compared to our earlier estimate of 4.6%). But focusing on the GDP revisions is focusing on the symptom and not the cause. Instead, the really sobering aspect of the data is that the downward spiral of private investment – with its implications for capital stock, productivity and therefore potential growth – continued unabated in FY13.
FY13 GDP revised down to 4.5% from 5%
Economic growth was even weaker than 5% – already the lowest in decade – that had been initially estimated for FY 13 (year ending March 2013), with revised estimates marking growth down further to 4.5% oya. To be sure, this came on the back of an upward revision to FY12 (6.7% from 6.2%) but that, in turn, was on the back of a downward revision the previous year (8.9% from 9.3%). Netting through all the changes the impact was negative: the level of GDP in FY13 was 0.4% lower than earlier estimated.
The cumulative impact: level of industrial and agricultural activity marked-up, services down
So what drove the cumulative reduction in activity by FY13? Agricultural growth was revised up sharply in FY11 (7.9% to 8.6%) and FY12 (3.6% to 5%) and despite the downward revision in FY13 (1.9% to 1.4%), the level of agricultural output was still 1.4% higher by FY13 than previously estimated.
Industrial output, similarly, got a net upward revision. While growth in FY11 was marked down meaningfully (9.2 to 7.6%) FY12 saw a whopping upward revision (3.5 to 7.8%) while weak FY13 growth of 2.1% was further reduced to 1% oya. However, the strength of the FY12 revision meant that the level of industrial output after the cumulative revisions was 1.5% higher in FY13 than was initially estimated. Within this, the level of manufacturing output saw a sharp cumulative upward revision (3.9%) by FY13 while the level of construction output was marked down 2.5%. The significant mark-up to manufacturing and industrial growth in FY12 ties in with the fact that pricing power may have been even stronger than presumed and therefore explains why core WPI inflation was so stubborn and elevated that year.
In contrast, the services sector saw markdowns in all three years: a sharp downgrade in FY12 (8.2 % to 6.6%) and modest markdown (.1 %) in each of the other two years. Consequently, the level of services output in FY13 was 1.7% lower than initially estimated. Within services, the key casuality was trade , transport and services which was marked down 4% cumulatively across the three years. Community services was also marked down 2.3% -- largely in FY13 reflecting the thrust on fiscal consolidation -- while financial and real estate was marked up 1.7% .
Immediate impact: lower base could statistically inflate FY14 growth
Ironically, the first impact of a net downward revision on growth in previous years could be to statistically-inflate the annual GDP growth forecast for FY14. This is because the revisions have resulted in the level of GDP output in FY13 being lower by 0.4 % than previously estimated, creating a more favourable “base effect”. Before the revisions, our forecast for FY14 growth was 4.6% oya. But, for any given forecasted level of output across the four quarters of FY14, the year-on-year growth’s rates will correspondingly rise because of the lower base. However, this is more of a statistical anomaly than a re-think on the economy’s fundamentals. It does not reveal that the sequential momentum was necessarily higher, simply that the starting point was weaker. Given the historical changes, we therefore mark-up our GDP forecast to 4.8-5.0 % vis-à-vis our earlier forecast of 4.6%. We range the revised forecast because it is still not clear to what extent some of the methodological improvements that were applied to revise the historical industrial data in FY13 are already embedded in the IIP data that is used to forecast growth in FY14.
The ever-declining share of corporate investment
Markets have undoubtedly focused on the markdown in headline GDP in FY13. But in doing so, they are focusing on the symptom rather then the cause. Instead, the real news in the data release continues to be the unabated downward tumble in investment rates, especially those parts of investment that typically drive productivity growth.
For starters, the aggregate investment rate (as a % of GDP) tumbled in FY13. It had been holding flat between FY10 and FY 12 at the 36% of GDP mark, which was still lower than the pre-Lehman highs of 38% and a bit deceptive, because the aggregate stability masked an adverse compositional change in investment, with more productive corporate investment being replaced by investment in gold and valuables. However, even that façade of stability disappeared in FY13. Aggregate investment fell a whopping 1.7 percentage points last year and – at 34.7% of GDP – is the lowest rate in seven years.
The details continue to be sobering. The ratio of corporate investment fell for a third year (by close to a percentage point of GDP in FY13), is now at a decade low of 9.2% of GDP, and is almost half the level it was in the year before Lehman (17.3% of GDP). To compound matters, household investment also declined a full percentage point of GDP in FY13, even as public investment saw a pleasantly surprising uptick and investment in valuables remained stuck at an uncomfortably high level, though some relief is expected in FY14 post the government’s all-out war on gold imports.
Equipment investment takes another blow
Another way to cut the data – from an economically meaningful standpoint – is to break aggregate investment down into structures and equipment, given that it is the latter the embeds technological change and correlates closely with productivity growth. Here, too, the news is sobering.
Equipment investment which had fallen for three successive years post-Lehman edged up in FY12, raising hope that the worst was over. Instead, FY13 broughta rude shock with the equipment investment to GDP ratio declining by 1.1 percentage points of GDP, the largest drop seen in the last decade, and pulling down equipment investment to an 8 year low.
In contrast investment in structures (household, corporate and public sector) remained in the 17% handle where it has stabilized over the last four years. So the problem with the investment decline is two fold – not only is the moderation in total investment rates adversely impact the growth of capital stock, but the fact that the investment slowdown is occurring in machinery and equipment is likely pulling down productivity growth, and thereby constituting a double whammy on potential growth in India.
Savings also head south
Perhaps the only silver lining to an investment-drop off would be the presumption that an adverse investment-savings imbalance would narrow. But, unfortunately, there was little relief on that count too, because savings moderated almost in lock-step with investment.
In particular, aggregate savings declined by 1.2 percentage points of GDP such that the bloated investment-savings gap of 5 % of GDP the previous year only reduced to 4.6% of GDP in FY13 – though its expected to narrow substantially in FY14 as valuables investment reduces after the curb on gold imports.
The fall in saving was driven largely by household physical savings which moderated by 1 ppt of GDP. Corporate savings also edged down by 0.2 ppts of GDP and are almost 1.5 ppts of GDP lower than three years ago, which is understandable given that corporate profitability is under stress. In a pleasant surprise, house financial savings held steady, though at an abysmally low rate of 7.1 % of GDP compared to routinely being in the 11-12 % of GDP range until 2010.
Beyond the numbers: what to make of the data
Given the slew of data released, it’s easy to get lost in the numbers: X went up but Y went down. Instead, the totality of the data and revisions point to two broader conclusions. First the cumulative markdown in growth over the last three years, and especially the markdown in FY13 (from 5 to 4.5%) – and the fact that this weaker growth coexisted with stubbornly high inflation – further reinforces our belief (“India in 2014: five questions that keep us awake” MorganMarkets, Jan 2014) that potential growth has been moderating faster and sooner than had been presumed, and therefore output gaps were more positive (less negative) than had been assumed.
But this is still a symptom. Instead, the cause – as we have long been pointing out (“India in 2014: five questions that keep us awake” MorganMarkets, Jan 2014) – is that the decline in potential growth has been driven by a sustained decline in corporate investment and, in particular, machinery and equipment investment. These phenomena have both reduced the growth of capital stock as well as impinged on productivity growth (reflected in rising ICORs), constituting a double-whammy on India’s growth dynamics. Viewed from this lens, the FY13 investment data is truly sobering. Because it reveals that not only did these dynamics sustain, but they actually accelerated last year.
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