At 9.7% last fiscal, GDP deflator worrisome

The pincer effect of a tight monetary policy and high inflation appears to be taking a toll on the economy. The growth rate of real gross domestic product at factor cost during the final quarter of 2010-11 slumped to the year’s lowest of 7.8%; this is also a far cry from the overall economic expansion of 9.4% achieved during the same period of the preceding fiscal.

This setback was due, primarily, to the pummelling the economy received from manufactures, where the real GDP spurt was limited to a minuscule 5.5% in the latest quarter compared with a hefty 15.2% a year ago and a massive deceleration in the mining & quarrying sector  — to 1.7% from 8.9%.

This was compounded by an underperforming construction industry where the tempo had slackened to 7% from 8.3%.
Though agriculture had staged a strong recovery to 7.5% during the January-March period of 2010-11 from last year’s 1.1%, it was not sufficient to avert the economic deceleration as the fiscal came to a close.

Surprisingly, the tertiary sector which normally is a buoyant section of the economy had also been gripped by a slowdown of sorts; in aggregate terms, the real GDP originating from tertiary activities had shown a lower incremental growth of 8.7% than 10.2% during the same quarter of 2009-10.

However, despite the debacle in the last quarter, the GDP growth during 2010-11, at 8.5%, was broadly in conformity with the secular trend; it was also higher than what it was a year earlier (8%).

In its advance estimates issued in February last, the Central Statistical Organisation (CSO) had projected a spurt of 8.6%.
This has now been proved to be a tad higher. From the latest data, it is clear that the CSO had then underestimated the performance in the primary sector and overestimated the growth in secondary and service sectors. 

In both mining & quarrying and manufacturing, the GDP increase is now trimmed to 5.8% and 8.3%, respectively.

The relatively better showing in the last fiscal stemmed from a strong rally in agriculture (from 0.4% to 6.6%), construction (from 7% to 8.1%), trade, hotels, transport & communications (from 9.7% to 10.3%) and finance, real estate, insurance and business services (from 9.2% to 9.9%).

What is noteworthy is the marked weakening in the growth rate of community, social and personal services - to 7% from 11.8%.
What the CSO figures convey in clear terms is that the last fiscal year was characterised by spiralling prices and a downturn in investment activity.

Thus, while the real GDP had risen by 8.5%, the jump in nominal GDP was as high as 19.1%, the gap between the two representing the money illusion fostered by galloping inflation.
In 2009-10, the GDP deflator had declined by 2.4% but in the following year, it had risen by a worrisome 9.7%. In the final quarter, there has been a moderation of sorts at 8.8%, but it is, nonetheless, rather high.

The GDP deflator refers to the cost of goods produced relative to the purchasing power of the rupee. It is calculated as nominal GDP (GDP plus inflation) divided by real GDP (GDP minus inflation) x 100.
Similarly, in regard to investment, the rate of gross fixed capital formation, a measure of investment activity in the economy, had eased to 29.5% during the year ending March 2011 from 30.8% in the earlier year.

During the last quarter, this rate had dropped to 29.6% from 32.7% during the previous year’s comparable period.
It would appear from the latest GDP numbers that the dear money policy which was intended to tame the price fever even if involves a negative impact on economic growth — the so-called trade off between inflation and growth — is not working as intended.

Certainly, it has hurt growth — the deceleration in real GDP at factor cost has been pronounced, 9.3% in the first quarter, 8.9% in the second quarter, 8.3% in the third quarter and 7.8% in the fourth quarter - but the inflation rate is also still unconscionably high, being close to 10%.

That the investment activity is subdued  is revealed by the quarter-wise data and the fact that the rate of fixed capital formation is lower than in 2009-10 for three successive quarters and only a shade better in the first quarter of 2010-11.

There are few surprises in the CSO numbers. The Reserve Bank of India may, therefore, press the pause button rather than resort to any fine-tuning at this stage.

Some moderation seen in the inflation rates of late, though quite high, may also deter the central bank from altering the status quo in the monetary stance it had adopted recently.