The US stock markets were in a celebratory mode yesterday as the Q3 2009 GDP grew by 3.5% in real terms, better than what the economists were expecting.
First, the details. As per the US Bureau of Economic Analysis (BEA), the GDP grew by 3.5% after contracting for four consecutive quarters. This, in fact, has been the longest and deepest recession in the post-war period. Real final sales rose 2.5%. The contribution of private inventories’ to the GDP growth turned positive at 0.94%. Real personal consumption expenditure (PCE) grew by 3.4% (as against a decrease of 0.9% in the previous quarter) as the "cash for clunkers" programme boosted durable goods consumption (22.3% versus a decline of 5.6% earlier). Fact is, motor vehicles and parts added 1.0% to GDP growth. Not surprisingly, private investment also moved to positive territory (11.5%) as the residential investment rebounded (up 23.4%) although there was a smaller contraction in non-residential investment (-2.5%). Government expenditure slowed to 2.3% due to the decline in state government spending. However, with import (growth of 16.4%) picking, there was a negative contribution of net exports to the GDP growth to the extent of 0.53%.
While the growth rate does look impressive, question is, is it actually so? Not really. Firstly, there is a technical aspect to this growth. The change in real private inventories added 0.94 percentage point to the third-quarter change in real GDP after subtracting 1.42 percentage points from the second-quarter change. Fact is, private businesses decreased inventories $130.8 billion in the third quarter, following decreases of $160.2 billion in the second quarter and $113.9 billion in the first. While inventories are still being drawn down, the pace of draw down has clearly diminished. Hence the second derivate of inventories (i.e change in the change in inventory) has turned positive. Going forward, inventory built up will slowdown because I fear contraction of consumer spending.
Most of the analysts who has commented on the Q3 GDP release have talked about the positive effect of the ‘cash for clunkers’ scheme(which ended in August) in pushing up the PCE for the quarter. According to some estimates, increased auto sales, directly attributable to the above programme, was to the tune of 700,000. But the bigger issue is, sales plummeted the very next month in September after the programme was withdrawn.
The rebound of residential investment has also a lot to do with the incentive offered by the government to first time home buyers. A credit of USD 8,000 is indeed a big deal. And this programme expires in November. In case the programme is not extended any further, then one can expect residential investments to drop off. In fact, even before the scheme ended, new home sales dropped a tad in September.
End of the day, it is the US consumers and their ability to open up their wallet that will drive and sentiment as well as the economy. And, this does not look good. During the third quarter, there has been a surprising drop in disposable personal income (DPI) to the extent of USD 20 billion. A closer look at the data reveals an interesting aspect. While, given the increasing level of unemployment, the wages and salary component has expectedly declined (and has been declining), what has been holding up the number in the previous quarter was rising transfers (unemployment benefits) and lower tax incidences (tax breaks given by the government). Each of these components faltered in this quarter.
Let’s first take unemployment benefits. In the US, an unemployed person is entitled to unemployment benefit for a period of 26 weeks only. Therafter, they cease to get the benefit. As mentioned earlier, this has been the longest and deepest recession (see chart below) during the post-war period. As a result, people have remained unemployed for much longer period of time.
Source: Bureau of Labour Statistics
As can be seen, the average duration of unemployment touched 26.2 weeks in September 2009, highest ever recorded. As a result, a large number of people have been falling off the statistics of those people who are eligible for unemployment benefits. With the decline in Unemployment rate slowing down, the number of people in the 15 to 26 week bracket (i.e those who would be eligible for the unemployment benefit) were down by 510,000 during Q3, while more than a million people became ineligible for the allowance having failed to find a job for more than 26 weeks. Not surprisingly, transfer income received during this quarter was lower by USD 9 billion. Additionally, the tax breaks that the government was giving to the residents in the previous quarters were withdrawn during Q3, resulting in higher incidence of personal tax. During Q3, personal tax paid out rose by about USD 5 bn. Not surprisingly, the PDI was down substantially.
As mentioned earlier, despite the PDI being lower, PCE rose mainly because of the various stimulus package that was available. Going forward, these packages would no longer be available. Additionally, as the unemployment rate slowly inches up and more and more people end up using the 26 week window for claiming the unemployment benefit, what to talk of disallowance of the tax breaks, the PDI is likely to move south. In addition, as we all know, the recovery that would be visible in the near future would be jobless.
Additionally, as I have discussed several times earlier, the US consumers are still highly indebted.
Indebted consumers, increasing job loss and withdrawal of stimulus are a potent combination of disaster waiting to hit the US economy. To me, this is a highly technical recovery which is not going to be sustainable in the near future. In fact, the consumer spending number released today gives an inkling of what’s coming, as it shrank 0.5% in September, the largest drop in nine months.
While talking about food price inflation in yesterday's Monetary Policy review, felt the need to come back to the issue of agriculture and the neglect it has to bear.
This time I would just like to focus Gross Capital Formation (GCF) in agriculture which is a proxy of investment made in that sector.
Share of agriculture in total GCF in the economy (%)
Source: Economic survey
As the table shows, there is a continuous decline the share of agriculture, as far as investment is concerned. As of now, GCF in agriculture account for a measly 5.7 per cent to total GCF while agriculture accounts for close to 20 per cent of India’s GDP. In a related finding, a World Bank Working Paper (M. Ravallion, 2002) showed that whenever there is a need for contraction in spending by the government, social sector tends to be worst affected.
Indeed, investment in this sector remains a soft target as the government continues to struggle with its expenditure management, given its profligate ways. Even when the economy was growing at around 9 per cent and revenue was growing fast, deficit continued to be a bugbear. Conservation of resource as a policy did not find favour. Hence, the government of the day followed the easy way out, that of statistically reducing the deficit by removing a few items from the ambit of deficit calculation, irrespective of the fact that financing of those items continue to burden the economy.
As expected, the RBI kept the interest rates unchanged during the Monetary Policy review today. At this point in time, the RBI is faced with two divergent concerns – growth and inflation. Currently the growth concern correctly held the centre stage. As a result they decided to keep the interest rate unchanged. The feeling naturally is that, any tightening of the monetary stance can impact the nascent growth that is visible now. However, RBI has indicated that it cannot continue to be oblivious to inflationary concerns. Hence, while the interest rate remains unchanged for the time, the central bank is giving enough indication that the excess liquidity that is currently in the system needs to be sucked out. To this end, they have hiked the SLR requirement from 24% to 25% and they have indicated that RBI would look at exit strategy at the earliest. RBI is clear in their view that the excess liquidity that is in the system will lead to higher inflation. Which is why, they increased their expected inflation to 6.5% in March as compared to their expectation of 5%, which was given out a few months back.
I, however, beg to differ on this text bookish interpretation of inflation by RBI. For one, the rising inflation has a lot to do with the base effect. Also, if one looks at the corporate performance data during the second quarter, it is clear again that most of the companies recorded a much higher margin while the sales have virtually stagnated. The higher margins are due to lower input costs, lower interest costs and of course lower wage bills. If input costs are lower, then clearly the pressure on inflation comes from some other avenue. And it is clear that it is the rising food prices which are driving the inflation. And, I do not believe that monetary policy has much impact on food prices. Liquidity has very little to do with food price movement. The problem is much deeper that RBI would want us to believe. The malaise afflicting this sector is beyond the control of RBI. For one, the current food price inflation has a lot to do with monsoon failure and, to my knowledge, domestic monetary policy cannot impact the will of god.
On the other hand, despite the excess liquidity situation, credit growth to the real economy leaves room for desire. In fact, the central bank has actually reduced their target credit growth from 20% to 18%. With domestic demand not rising much (as is reflected in generally stagnant corporate revenue and continuously lower non-oil import) and lower credit growth, the economy would be hard pressed to cross the 6% growth mark during this financial year.
The stock markets withdrew today because they are expecting RBI to increase the interest rates going forward. I feel they are mistaken. I am not sure that RBI will walk that path, since this can threaten the recovery.
The focus might continue to be to suck out liquidity so as to prevent the excess liquidity from getting into speculative mode which can lead to asset price inflation not supported by underlying economic fundamental. In fact, globally a lot of economies are experiencing such asset price inflation.
The only concern currently is, while it is important to prevent the excess liquidity to get into a speculative mode, RBI should not be too hawkish and suck out liquidity so much that the economy starts to hobble. For this, mere focus on inflation to decide on the monetary stance would mean that RBI might be barking up the wrong tree.
Among other measures reported:
The RBI has asked banks to ensure that their total provisioning coverage ratio is not less than 70% and imposed a timeframe of September 2010 to achieve this target. The coverage ratio is a measure of the bank’s ability to absorb potential losses for non-performing assets (NPAs) and is arrived at by calculating the loan loss reserve balance with the total non-performing loans. Clearly with the recent global turmoil fresh in mind, the RBI does not want to take much chance. While nobody can fault RBI for trying to being cautious with the experience, one hopes that the central bank would be flexible in their approach and take steps to ensure that availability of liquidity to the real economy and at reasonable rate. Fact is, increasing provisioning requirement will lead to increased borrowing cost and the banks might be forced to pass the same to the borrowers, which can be debilitating for economic recovery.
Most banks will thus have to significantly raise the coverage ratio, which is quite low for some banks. This has the potential to impact the bank’s profitability and this is reflected in the beating that many bank stocks took today in the market.
The central bank also increased the provisioning requirement for advances to the commercial real estate sector classified as ‘standard assets’ from the present level of 0.40% to 1%, a move that makes lending to the sector tougher. This definitely is a move in the right direction. Earlier, the central bank has been too lenient on the realty companies, which allowed them to survive the difficult situation most of them have passed through. Fact is, this is not a well regulated sector and the real estate companies have generally had a free run at the cost of buyers, especially when the going was good. But when their rogue business practices put them in a soup during the market meltdown, they sought for and got more than warranted level of support from the central bank. As a result, the real estate companies felt no need to change the way they do their business which leads to creation of bubble. This move by RBI would help build cushion against likely non-performing assets.
To conclude, while the RBI has done the right thing to focus on preventing likely bubbles. However, doing the same by solely looking at inflation need not be the right thing. Going forward, there is a threat of likely increase in finance cost for the borrowers.
I do not expect any change in the in the accommodative monetary policy stance by the RBI in the review to be held tomorrow. The economy is far from being out of the woods at this point in time, despite what the stock market might have made us believe or what the government machinery is trying to make us believe. At this point in time, a 6.5% growth rate of GDP seems to be quite far-fetched.
While I have discussed the issues in various articles over a period of time, I would like to bring forth a couple of recent developments that might hold the key.
1st is excise duty collection data. Till August, the Apr-Aug’09 cumulative collection figure was down by about 25%. Agreed, as part of the stimulus package, the government announced reduction in duties for various commodities and this is also reflected their budgted collection of excise duty for 2009-10, which was assumed to be lower than by about 1.75% as compared to the previous year. Nevertheless, the surge in August collection (around 23%) as compared to July’09 was a harbinger of hope. This was in line with the IIP growth of above 10%. However, the latest data for the month of September dashed the hope. The September number was down by about 5% as compared to August’09 and the Apr-Sep’09 collection is now down by around 21%. This means that the excise collection has to grow by close to 21% every month if we are to match the targeted collection. I have maintained earlier that the recent surge in manufacturing activity had a lot to do with increased inventory creation keeping in mind the festive period. Whether this is sustainable is a question. And, as the September number shows, things are not as rosy as one is made to believe.
Same is the issue with corporate tax collection. Corporate tax accounts for about 35% of total tax collection and the government expects the corporate tax revenue to jump by 15.64% in this fiscal. However, for the period Apr-Aug’09, corporate tax has increased by a mere 2.47%. This means that for the next seven month, corporate tax has to increase by 20.84% month-on-month to achieve the target. Again a very tall order. Clearly, the corporate sector, overall, is not growing as much.
And, this brings me to the 2nd point. Like the first quarter of this fiscal year, a study by ET of about 400 non-finance companies show that while their net profit grew by as much as 22%, their net sales grew by only 4%. Clearly such profit growth (based as it is on cost control lower wage, input and interest cost) is not sustainable. Sustainable corporate profit growth requires growth in revenue. Stagnation of revenues indicate slowing down of demand.
All of these continue to mean that the problems are ‘far from being over and hence I expect no change in the government’s accommodative monetary policy stance tomorrow.
Is India hoping for a Malthusian solution for the population problem? Sounds weird? Maybe not. Read on.
First the chart.
Source: Handbook of Statistics on Indian Economy, RBI
Indian agricultural sector has always been a recipient of lip service what with our policy makers mostly failing to walk the talk. A sector which is the largest recipient of general and governmental apathy, has been on a decline. Supporting nearly 65% of India’s population, story of this sector has been a saga of faulty planning and underinvestment. Result?
Alarming decline in the growth rate of food grain production! The compounded annual growth rate (CAGR) of food grain production declined from about 4.5% in the 80s to 2.06% in the 90s to as low as 1.21% during the first nine years of the current decade. So much so, during this current decade, while the growth rate in food grain production is failing to keep pace with population growth. In the current decade, the average population growth rate has been 1.59%. Are we not heading for a food scarcity.
Add to this the high incidence of poverty and malnutrition, and one is tempted to believe that India prefers to follow the Malthusian law to keep the population under check. So much for our growth and development!
The US economy is likely to see a technical rebound during Q3 2009. Technical because the inventories have been drawn down to such a level that pace further draw down will diminish. In fact, there is some increased activity in order to replenish the level to a certain extent. Higher activity was also visible as long as the ‘cash for clunker’ scheme was operational and will also be visible in the residential segment (along with associated sectors) for some time till the credit scheme of USD 8,000 is available to first time home buyers. After this scheme expires in November, activities will be further diminished, unless life of the scheme is extended or is extended to other segments of home buyer. Added to this is the low base effect.
Fact, however, is business is not confident on the sustainability of growth as are lenders still not confident on the repayment capability of borrowers leading to tighter norms. As a result, the real economy is deprived of much needed credit.
As can be seen from the chart below, bank credit (along with all its components) growth rate has been faltering since early 2009, with commercial and industrial (C&I) loan peaking as early as March 2008.
As I have been maintaining all this time, it is quite clear that the the US economy is running on steroids. After the cash for clunkers scheme, the only remaining catalyst for consumers is the home purchase credit. With the scheme likely to come to an end in November, the builder confidence in the market for newly built, single-family homes slipped one point to 18 in October, according to the latest National Association of Home Builders/ Wells Fargo Housing Market Index (HMI).
“This is the first time since November of 2008 that all three component indexes of the HMI have declined,” noted NAHB Chief Economist David Crowe. “Clearly, builders are experiencing the effects of the expiring tax credit on their sales activity, since it would be virtually impossible at this point to complete a new home sale in time to take advantage of that buyer incentive before Nov. 30.”
On the flip side of the coin, Crowe noted that immediate congressional action to extend the tax credit and expand its eligibility beyond first-time buyers could substantially boost sales activity. “In a special questions section of our HMI survey, 85 percent of respondents said that expansion of the tax credit would have a positive impact on their sales,” he said. “That would amount to a very effective stimulus to housing demand and a needed boost to the overall economy.”