China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

India: The Present Economic Outlook

June 7, 2013

In the fiscal year ended March 2013, the Indian economy turned out its weakest economic growth in a long while. The provisional estimates released at the end of May 2013, reported that the economy grew by 5.0 per cent, terribly weak compared to even the crisis year 2008-09, when India managed to close the year with 6.7 per cent growth. An economy of more than 1.2 billion people, the majority of who are poor by any global benchmark and where tens of millions of youngsters are coming out of school and college each year in search for jobs and livelihoods, depressed growth is very bad news. The average annual rate of growth for the eight year period from 2003/04 to 2010/11 was 8.6 per cent. The average over the 20-year period 1992/93 to 2010/11 was 7.0 per cent.

In the two years immediately following the crisis year, namely in 2009/10 and 2010/11, the Indian economy grew by 8.6 and 9.3 per cent respectively. So why did growth slump to 6.2 per cent in 2011/12 and to 5.0 per cent in 2012/13? And what is the near-term outlook and prognosis for growth? Is a revival possible in 2013/14? These are questions that hang like a heavy cloud over both policy makers and economic analysts. For the magnitude of the slump in the second half of 2011/12 to 5.5 per cent was surprising, as was the persistence of slow growth in 2012/13.

Broadly the answer to the question of why the slump happened appears to lie in three separate elements. (1) The first is that the vigour of the recovery from the crisis year was underestimated in the preliminary estimates of economic growth. This led to some delay in adjusting the fiscal and monetary stimulus that had been rolled out to counteract the effects of the crisis in 2008/2009, which in turn allowed inflation to be pushed up to unacceptably high levels. This in conjunction with rising world commodity prices undermined profitability. The impact was compounded by a significant depreciation of the national currency. Companies saw their operating margins decline, and corporate profit growth was weak. (2) Plans for equity infusion had been deferred by many companies as the crisis unfolded. They had kept capital flowing into projects by taking on more leverage than originally envisaged. The shortage of equity has however persisted into present times. This combined with declining profitability has stretched balance sheets painfully. Hardly a condition that is favourable to business expansion and investment. (3) Beginning earlier, but becoming more painful since 2010, projects started to face numerous problems in securing clearances from administrative departments to carry forward their projects. These difficulties were complicated in the context of judicial decisions and guidance in some cases. All of this also had adverse impact on the quality of banking assets, as banks play a big role in funding projects in India.

Aside from soaring inflation, the deterioration of macro-economic conditions stemming from deterioration in fiscal conditions and the external payments situation, together with contentious domestic political climate and high level of rhetoric negatively impacted economic conditions. Compounding this was the malaise in the global economy. The generally depressed state of global business sentiment was reflected in weak business confidence within India.

In many ways this was a perfect storm. So many unrelated problems came together in a short span of a few years. The hubris that unfortunately arose from the successful negotiation of the global economic crisis certainly prepared the ground for a high-impact letdown.

Where do we stand today? The fiscal trajectory has been corrected. Politically difficult decisions in rationalization of fuel prices, re-prioritization of expenditures and some other steps to boost revenue, has seen the fiscal deficit undergo strong correction and in the current year 2013/14 will stick to target. Long-standing decision on permitting foreign direct investment into certain areas and other reforms did not come cheap. An important partner in the ruling coalition left the government in September 2012, and another went in early 2013. However, the government has persisted in the right direction and overall macroeconomic policy has undergone the necessary stabilization.

Important re-jigging of the way clearances are given to projects has been undertaken and a higher powered committee of the Cabinet has facilitated the clearance of a large number of large investment projects. The government is energetically pursuing every opportunity to push for the execution of investment and asset creation in the public sector and to encourage private business to expand and invest. Over time, possibly in the second half of 2013/14, these measures should result in renewed investment activity.

Notwithstanding the sharp decline in growth, investment and savings rates remains favourable. Gross domestic capital formation in 2011/12 and 2012/13 were at 35.5 per cent of GDP in both years. This was lower than what it had been in 2007/08 (38.0 per cent) and in 2010/11 (37.0 per cent), but are still reasonably high. On the basis of historical relationships in India between investment and growth, this level is capable of generating 7 to 8 per cent rates of growth. The proportion of GDP going to create fixed assets (fixed investment rate) was about 30 per cent in both 2011/12 and 2012/13. The domestic savings rate for 2011/12 was nearly 31 per cent and probably close to that in 2012/13. In short, the domestic investment and savings rate are still at levels that can produce much stronger growth than has been evident in both of the two previous fiscal years.

That it has not, is in part, on account of the delays that has inflicted projects in India on account of clearances, fuel availability and other delays. For example, there is at the moment, more than 10,000 megawatts of thermal power plant capacity that is wholly or largely idle on account of non-availability of natural gas and coal. Likewise there are many projects that have got delayed in their path to completion, even as billions of dollars of capital has been invested in them. It is the belief of government that actively pursuing reform in policy and administration and facilitating the completion of such projects, the invested capital will be able to generate considerable incremental current output, that is, economic growth. It is not as if there is no market in India for incremental supply. Indeed the converse is true. The shortage of infrastructure services – electricity, roads and the like – seriously constrain output in India.

The positive developments that have materialized in India over the past year are: (1) Stabilization of a range of macro policies; (2) Restoration of the trajectory towards fiscal consolidation; (3) A decline of wholesale price inflation from double digit levels to about 5 per cent, which is within our comfort zone. Manufacturing output remains depressed as also measures of business confidence. However, there is a strong possibility that hard numbers will begin to show improvements in coming months and that there will be some degree of recovery in the second half of the year, which in turn should lay the foundation for a stronger and more broad-based economic recovery in 2014.
June 4, 2013

 

 

 

 

Saumitra Chaudhuri
Member, Planning Commission & Member Advisory Council to the Prime Minister and the Government of India

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“Secrets of Mexico’s Pacto”

Mexico has emerged as an emerging markets darling, with some editorials praising it as the “New China”. Is this a fair assessment? While it is true that Mexico’s wage cost competitiveness has improved relative to China, its broader productivity record has been very weak in recent years. Slow productivity growth has been limited by a lack of full implementation of earlier reforms, and difficulty in passing reforms in key remaining areas. The reform record of the past several months is encouraging — even astonishing — in its scope. Major reforms have been made to boost competition in telecoms, strengthen the education system, improve labor market flexibility and make local governments more accountable. Moreover, these reforms are not just incremental reforms: even “painful” and substantial constitutional changes are being passed, such as the telecommunications reform that was approved by state legislatures a few weeks ago. Many of these reforms the OECD has long advocated in its policy advice, notably in its Economic Surveys.

The gamut of reforms that have been passed makes one wonder what is the secret to all of this reform? A key part of the answer is its “Pacto por Mexico”, a consensus-based commitment to pass a package of reforms. This political vehicle has reduced the political opportunity cost of passing difficult reforms, by ensuring that all major parties take responsibility for their passage. The politically savvy technocrats who designed the Pacto include a number of former legislators, and their experience has helped immensely.

Economic growth has been too slow in recent decades to narrow the gap with the rest of the OECD, and it has been insufficiently inclusive to durably reduce poverty. This is mostly because the all-essential “multifactor” productivity has been a negative contributor to growth, after accounting for demographics and capital accumulation. In the long run, productivity should be the primary source of growth. Reversing the stagnation in the income gap with the rest of the OECD, and reducing income inequality will require “deep” structural reforms to address widespread informal employment and weaknesses in legal institutions, which diminish the effectiveness of many policies. These weaknesses particularly hold back gains in productivity, in part by limiting the scale of production and also by imposing barriers to reallocation.

While there is no silver bullet to eliminate informality, new OECD evidence presented in the latest Survey suggests that a broad package of reforms can help immensely: strengthening educational outcomes, improving the regulatory environment and reducing corruption are all essential intermediate steps to do so. New legislation and regulatory reform are needed to remove remaining barriers to market entry – especially at the sub-national levels – as well as reduce corruption and make the justice system more effective. While these goals are partly addressed in the Pacto’s commitments, policymakers must not be complacent, nor stop when the “going gets tough”. Ongoing reforms and follow-through are essential.

The OECD’s Survey recommends the creation of an ongoing high-level inter-agency body focused on productivity that can study and help to promote structural reform.

Boosting productivity and achieving the range of competition reforms envisioned by the administration will require stronger judicial institutions to enforce laws and adjudicate disputes. Judicial effectiveness relies not only on legal origin, but also on the efficiency of the court system, the quality of administration, the nature of legal codes and the soundness of procedures. Analysis carried out in the context of this Economic Survey suggests that a low-quality judiciary makes contract enforcement problematic, reducing the size of firms and capital intensity, thus limiting overall productivity through diminished economies of scale. Major reforms to the civil and criminal judicial systems are underway, yet faster progress needs to be strived for.

Those reforms that have been carried out in recent years have already improved Mexico’s macroeconomic performance, helping to support the economy’s solid recent growth record – which we believe will continue at a pace of about 3½ percent – and increased its resilience to repeated international shocks. However, it is critical that the reform efforts don’t slow down, and implementation is not forgotten. Mexico has no time to lose. In order to durably raise living standards and well-being for all Mexicans, many more reforms are still needed, and considerable follow-through or implementation of previous reforms is still required in most policy areas.

http://www.oecd.org/eco/surveys/mexico-2013.htm

 

 

 

 

 

Sean Dougherty
Senior Economist and Head of the OECD’s Mexico Desk

 


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The Mystique of the (Chinese) Purchasing Manager Index

PMIs (Purchasing Manager Indices) use to be interesting readings. PMIs have three advantages.

First, they are the fastest of the published short-term business-climate indicators. They are published for manufacturing – which is the most important one – and services just a few days after the surveys have been concluded and only around two weeks after the questionnaires have been sent to the purchasing managers. Second, purchasing managers operate quite early in the planning and production cycle of a company which gives them a “competitive analytical advantage”. Third, purchasing managers are usually very skilled also what concerns the business climate in different sectors and countries – both in an aggregated and an individual corporate perspective. This broad analytical approach is necessary to manage successful price negotiations. This assumes knowledge about price and wage trends, currencies, etc., too.

I feel safe in these conclusions since I introduced the PMI via SILF/Swedbank in Sweden myself almost twenty years ago – roughly at the same time as the UK did (which meant that the UK and Sweden were the first countries outside the U.S. to produce the PMI numbers for manufacturing). Now the PMI can be found in almost 40 countries, China included.

China even has even two PMIs. One – the official one – is produced by the China Federation of Logistics & Purchasing (CFLP), the other one by the large financial institution HSBC in co-operation with the research house Markit in the UK. Usually, these two indices do not have exactly the same numbers for the same month. Sometimes, directions may be even (somewhat) different. During the roughly eight years of their common existence, the HSCB PMI tended to give somewhat lower numbers than the index prepared by the CFLP (however less obviously in the past few years).

These statistical differences may have several reasons. For example, the number of participating companies in the CFLP survey nowadays is almost four times larger than the one of the HSCB PMI (which is not necessarily related to quality). It can also be added that the HSCP index seems to be more sensitive to changes in the exporting manufacturing sector. Other comments I have heart from Chinese and other economists point at weaker seasonal adjustment systems in the PMI system of CFLP. In my opinion, it could even be a mix of all these – and other – explanations. Transparency is simply too low in this respect.

Altogether: it is hard to really judge the quality of the two PMI indices. Despite certain shortcomings, they probably still deserve the reputation of being the best short-term industrial climate indicators in China (and many other countries). Unfortunately, financial markets so far have not always understood what PMIs really are all about. This includes the understanding of China’s PMI.

Five types of misunderstandings happen very frequently in this index system where a composite index below 50 is defined as a location in the declining area of industrial activity and above 50 as a result that indicates production growth in manufacturing.

–  Smaller deviations between result and expectations/predictions – for example, 49.4 compared to 50.1 – can be often practically very irrelevant even when financial markets at the same time express strong initial disappointment. The “50-points limit” should not be treated as an exact borderline between positive and negative industrial growth (yes: economists use the term “negative growth”).  Not in China either. In some countries, it is even discussed whether the borderline of index 50 still is valid or if another index number defines the growth and recession areas in industry more precisely.

–  The PMI is a diffusion index. This means that a relative limited number of purchasing managers who changed their current opinion on the PMI’s sub-indicators just a little bit compared to the previous questionnaire may affect the PMI number with 0.6 or 0.7 points. Deviations of this limited size may be (occasionally) given too much attention by financial analysts and the press.

–  The PMI does not say anything about the strength of the changes. A (slightly) falling PMI number may in reality be much less alarming if the negatively answering companies only have been affected by very small downturns in, for example, new orders, production or employment (the same can be concluded when index numbers move in the other direction). Again: the PMI does not register the magnitudes of changes during the past month.

–  PMI numbers should not only be examined on a monthly basis. When I prepared the monthly PMI index and reports on behalf of SILF and Swedbank until 2008, I always made graphs for three/six months moving averages as well. This kind of exercise made the PMI graphs (somewhat) less volatile and my own reactions many times more relaxed.

–  Thus, too little emphasis is usually given to somewhat more historical studies. Comparisons with the same month one year ago may be quite useful. Such an easy approach makes the analysis of current index levels somewhat easier to interpret.

To summarize: China’s PMIs may have weaknesses – also when it comes to parts of methodology and transparency (but one can observe these kinds of shortcomings in other countries as well). Monthly PMI numbers should get somewhat less focus than it is nowadays often is the case. The use of moving averages could be preferred in certain applications. But the PMI still tells us quite a bit about the temperature in the industrial (and service) sector. That’s why it is important. This is true of China, too.

Hubert Fromlet
Professor of International Economics
Editorial board

 

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