Economics is infamous for the differences of opinion among its practitioners. Consensus is very rare. Interestingly, presently we have a consensus that India’s economic growth is decelerating; but there is strong disagreement on the nature of that growth deceleration and the policy initiatives needed to address the problem. From the market perspective, the important questions are: How serious is the slowdown? Is the slowdown cyclical or structural? When can we expect a recovery in the economy?
Slowdown is sharp
The slowdown is, indeed, very sharp. The FY2019 growth rate of 6.8 percent is the lowest in five years and the Q4 FY2019 growth rate of 5.8 percent is a 20-quarter low. If the Q1 FY 2020 growth rate also comes below 6 percent, which is very much likely, that would be serious deceleration. If this happens it would be the first time in seven years that two consecutive quarter GDP growth rates would be dipping below 6 percent. In such a scenario, growth revival will take time.
Is the slowdown structural or cyclical?
Cyclical downturns are normal. It has happened many times before. A simple equation in macroeconomics will help to understand the nature of the slowdown.
From the expenditure perspective GDP growth has four components: Consumption, Investment, Government Expenditure and Net Exports. This is expressed in the form of a simple equation:
GDP= C+I+G+ (x-m)
where C=Consumption expenditure, I=Investment expenditure, G= Government expenditure and (x-m) = net exports. Deceleration in growth can happen due to decline in any of the four components. Of the four components, export growth has been sluggish during the last five years. Government expenditure has been steady and growing. Consumption demand has been growing steadily, till recently. The real issue has been the steady decline in private investment. Savings and investment have been declining steadily. There are structural issues here.
Consumption slump is cyclical
Private consumption demand growth has been steady at 8 percent for the last four years. Therefore, there is nothing structural about the consumption demand decline. The sharp slump in consumption demand is a recent phenomenon, which can be traced to the NBFC crisis. Therefore, consumption slump is more cyclical.
The NPA crisis in the banking system and the Prompt Corrective Action (PCA) ordered by the RBI severely constrained many PSU banks. Problems of capital inadequacy and restraints imposed by the RBI led to sharp fall in bank lending. The consequent gap in credit growth was largely filled by the NBFCs which succeeded in raising huge capital. The share of NBFCs in total loans rose sharply from 12 percent in FY 2012 to 23 percent in FY 2019. This sustained consumption growth. But the scenario completely changed with the IL&FS default and the market soon discovered that the Asset Liability Mismatch (ALM) is a deeper problem plaguing the NBFC segment. The problem became a major crisis with the DHFL default. With the exception of sound NBFCs, others found it difficult to raise funds and a liquidity crisis ensued. When the NBFC funds and credit dried up, it impacted consumption demand, particularly in segments like automobiles. The banking sector, stressed under huge NPAs, and witch-hunting by government agencies for laxity in lending became risk-averse and drastically cut down on lending. The slump in consumption demand is largely the consequence of this stress in the banking sector and crisis in NBFCs. This is a cyclical issue which is presently being tackled by liquidity infusion and rate cuts by the RBI. Even though the monetary transmission is weak, this monetary stimulus can be expected to produce results after a lag of two to three quarters.
Investment slowdown is structural
The prolonged private investment slowdown is largely structural. Government has been doing the heavy lifting in investment for the last few years. Presently, there is no room for fiscal stimulus since the Public Sector Borrowing Requirement (PSBR) at around 9 percent of GDP is swallowing the entire financial savings in the economy. In all likelihood the fiscal deficit target of 3.4 percent for FY 2020 will be exceeded since the ambitious revenue targets will be missed in this phase of growth slowdown.
With poor monetary transmission and limited room for fiscal stimulus, growth revival becomes a challenging task. So, how do we revive investment and growth? How do we break the vicious cycle of low savings-low investment-low growth and move on to the virtuous cycle of high savings-high investment-high growth? There are a variety of prescriptions on how to do this. These include borrowing abroad through sovereign bonds exploiting the global low interest regime, bold moves on privatization to send clear business-friendly message, part monetization of the fiscal deficit etc. Renowned experts like Dr Rangarajan strongly argue for aggressive disinvestment and using the proceeds for capital expenditure to revive growth.
Wanted: Confidence-building measures
It is a fact that business confidence has been seriously impacted and animal spirits have taken a big knock. Policy mis-steps like the higher surcharge on FPIs registered as trusts, witch-hunting of bankers and harassment by over-zealous bureaucrats and tax personnel have all contributed to the erosion of business confidence. This is, perhaps, the most important issue that needs urgent attention and action. Confidence restoring communication from the Prime Minister himself through his interview to ET and the Independence Day address are reassuring. But the government needs to walk the talk. This government has the political space to address this issue. Will the government bite the bullet? Let’s hope for the best.