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Economic slowdown might be more than a passing cycle of low demand | Opinion

What has caused India’s slowdown and when will GDP growth pick pace again? Answering the second question actually depends on the first, about which there’s considerable debate.

opinion Updated: Sep 12, 2019 16:50 IST
Zia Haq
Zia Haq
Hindustan Times
Finance minister Nirmala Sitharaman, addressing the media on her government’s crossing of 100 days in office on September 10, passed off the slowdown as part of the cycle.
Finance minister Nirmala Sitharaman, addressing the media on her government’s crossing of 100 days in office on September 10, passed off the slowdown as part of the cycle. (ANI)
         

India’s festive season, a period of frantic sales, is just around the corner. Hindus consider it an auspicious occasion for bringing home anything: gadgets to gold. Factories should have been clanking away. Car dealers ought to have been stocking up. To meet this front-end demand by consumers like you and me, back-end steel, aluminum, plastic, coal, power and cement consumption should have been at a high.

To meet the anticipated demand spike, corporates would be increasing their borrowings, resulting in a credit-flushed economy that makes for happy bankers and investors.

None of this is however happening. Latest data point to an economy fast losing steam. Gross domestic product (GDP) expansion came in at 5% in the first quarter (April-June), the weakest growth in six years. Unemployment is at a 45-year high. Concerns elsewhere such as in New York and London over a potential global recession make India’s slowdown only worrisome. If indeed such a recession does visit the global economy, India’s faltering economy would be a key trigger point.

What has caused India’s slowdown and when will GDP growth pick pace again? Answering the second question actually depends on the first, about which there’s considerable debate.

Finance minister Nirmala Sitharaman, addressing the media on her government’s crossing of 100 days in office on September 10, passed off the slowdown as part of the cycle. The government was responding to it adequately, she said.

Is it cyclical or structural?

So, is the slowdown cyclical or structural? The finance minister’s comment – that it’s all part of the business cycle – therefore suggests that the government views the slowdown as “cyclical”. Quite simply, the business cycle of any economy is said to encounter such routine ups and downs mainly because of a fall in aggregate demand (the sum of all the things each one of us in the economy might wish to buy).

Ordinary people wouldn’t care much about whether it’s a cyclical or structural slowdown. A slowing economy takes a real toll on real people. One example is the meltdown in the automobile sector. Unsold cars in their thousands are simply piling up. Hundreds have been already laid off

The economy is likely to shed more jobs. Corporate profits are dipping. Paychecks aren’t growing. Rural wages have slumped and farm profits are flat.

A cyclical slowdown, as the government would have us believe, should ordinarily respond to a set of first-line measures known as ‘fiscal’ and ‘monetary’ steps, which are the like Band-Aids to an injured economy. If the wound isn’t too deep and larger macroeconomic parameters are sound, these steps should get the economy moving again soon.

Fiscal measures refer to higher government spending. The government could also cut or reduce some taxes in the hope that a reviving economy will create enough revenue to offset these cuts. The idea is that higher spending will pump more money into the hands of the people, pushing demand back up. It’s a typical Keynesian response, named for the economist John Maynard Keynes, who guided America out of the Great Depression in 1930s.

That’s exactly what our finance minister did when she responded to the slowdown with a fiscal-stimulus package announced on August 26. She rolled back a super-rich tax on foreign and domestic equity investors, exempted startups from an ‘angel tax’, announced sops for the auto sector and cash infusion (worth Rs 70,000 crore) into public sector banks to boost lending.

India has tried the other Band-Aid too, i.e. monetary measures to heat the economy up. They mainly consist of slashing the main interest rates applicable in the economy to make borrowing cheaper because businesses generally need steady credit all the time. To push growth, the Reserve Bank of India (RBI) slashed the repo rate by 35 basis points to 5.4%. (A basis point is one-hundredth of a percentage point.) This was its fourth rate cut this year. This cut to the rate at which commercial banks borrow money from the Reserve Bank is squarely aimed at boosting aggregate demand.

Doctors don’t like to give away the secrets of what they do. But here’s how interest-rate manipulation works. Rate cuts are said to push up aggregate demand and inflation, easing the economy out of a slowdown. Some inflation is after all necessary!

Income growth is flat

The Indian consumer has turned skeptical because costs have gone up and incomes have stagnated. Crisil Research’s director Hetal Gandhi talks about a more sinister possibility. People’s investments are locked in stalled real-estate projects, squeezing their spending ability on other goods. She cites data from the Real Estate Regulatory Authority to show that not just new projects, the rate of completion of existing projects has come down too.

Total average earnings of farm households, according to her data, from agricultural related income, which includes rural labour wages, had a flat growth of 0% in 2018 at Rs 65,000 compared to an 8% rise in 2017.

Urban income growth from the formal sector, as reflected in cost of employees for 750 listed companies, which was averaging 10-12%, has fallen to 5% in the last quarter of 2018-19. If one looks at a six-quarter data of employee cost prior to quarter three of FY19, we saw growth rate per employee of 10-12%, which in the last quarter was 5%. Essentially this is what the number-crunching by Gandhi shows. An income crunch therefore is clear.

Savings dry up

India’s household-sector savings, the biggest source of investment for the economy, have “worryingly” dipped to a decadal low, while retail loans to the sector are growing annually in double digits. Financial liabilities of households are mounting, not a good sign. The country’s savings rate, or the share of gross domestic savings in the gross domestic product (GDP), has come down to 30.5% in 2018, latest available official data show, compared to nearly 37% in 2008.

Credit or loans are fast shifting from the corporate world to households because of India’s pile of corporate bad debts, known as the non-performing assets or the NPA problem.

Household savings are the largest source of funds for the economy, as they are a net supplier of funds to both the corporate and the government sector. In any economy, investments are taken to be the equivalent of savings because income not consumed must be saved, which is then used for investment.

India’s investment needs are generally far larger than can be met by domestic savings alone. The shortfall is met by costly foreign savings, which is what the country’s current-account deficit shows.

Poor savings have been a largely “un-addressed” reason for the country’s continuing slowdown, economist NR Bhanumurthy of the National Institute for Public Finance and Policy said in a recent conversation.

Deeper than we think?

Rate cuts haven’t helped things much. Fiscal stimuluses need time to take effect. However, some analysts have pointed to a more serious problem. The slowdown in India, Asia’s third largest economy, they argue could well be “structural”.

We have to ask three important questions to fully understand the macroeconomic problem at hand. Number one, what has caused the current instability, such that it has deviated from full growth potential and full employment output? Two, what should the government do? Three, economic theory holds that in certain situations, the economy is self-correcting. Will the economy self-correct?

Sometimes, the economy will self-correct because of its internal adjustment mechanisms. Suppose that inflation rises, leading to a fall in demand of certain goods known as items with ‘high elasticity of demand’. These are goods whose demand is said to be highly ‘elastic’, meaning these will be the first ones you’ll strike off your shopping list when prices go up. Responding to lower sales, companies may lower prices a bit. Demand could shift to cheaper alternatives. For instance, if butter prices go up, people could instead buy more margarine, a substitute. Slower demand will force companies to lower prices and these changes will ultimately restore the economy to its equilibrium.

Another example, of the opposite kind. Suppose that there is an increase in demand and consequentially an increase in both prices and production of a commodity, say a car. In the long run, salaries will rise. This will cause demand to go up (people with more money will buy more, that is). Eventually demand will outstrip supply and the economy returns to its normal position. These are of course simplistic examples.

The more important question sometimes is not whether the economy will self correct, but how long it will take for the economy to do so? Governments would not want to wait too long. The first steps therefore are usually fiscal and monetary.

What if the slowdown is structural, in which case fiscal and monetary measures may not work just as well.

A country’s GDP is the sum of four components i.e. private consumption, government consumption and investment plus net exports (difference between imports and exports). ‘Consumption’ is taken to be equal to ‘spending’. You can’t consume things if you don’t buy them after all.

India’s high growth previously had been running on the twin engines of government spending and private consumption. These two engines more than made up for weak activity in the two other levers, investment and exports, for some time.

Textbook economics says that growth should be led by investment, not consumption. Another structural weakness is India’s bad-loan mess, also known as NPAs, which are now the world’s largest, as a proportion of GDP.

A persistently flat farm-income growth looks like another structural driver of the current slowdown. Never has food inflation been benign for such a long spell. One reason is the routine gluts in about 36% of commodities. So, new exportable markets for agri surpluses must be found. A Goods and Services Tax that varies widely depending on commodities and demonetization (the Modi government’s decision to invalidate high-denomination notes) were structural shocks too.

The current crisis showed up prominently in the second half of 2018, when sales began slumping in what initially looked like a temporary softening of demand. The immediate trigger was the meltdown of the Infrastructure Leasing & Financial Services, which went bust last July. Policymakers have an onerous task because the slowdown after all may be structural and not merely cyclical.

First Published: Sep 12, 2019 14:07 IST