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Given that the repo rate is already around 5%, whether the same instrument can be used further and to what extent. This also brings the question of efficacy of this instrument in reviving the economy in current situation.
Now NSO has made it official! India strikes a GDP growth of 4.5% in Q2, 2019-20 and is the lowest in the last 6 years (since March 2013). This is the second consecutive lower than target growth in FY20. While the public spending is up, all the sectors have shown significant lower growth with manufacturing at a dramatic decline to -1%. Government finance is already under strain with fiscal deficit standing at 102% of the budget estimate in Oct – with 5 more months to go in FY20! Moreover, the recent price hike has added additional woe to the people and fuel to the Opposition. The aspiration of a 5 trillion economy in 2023 is becoming a distant target in the current scenario. It is time to be concerned about our growth – especially after a staggering average of more than 7% per year over the last decade (2009-18).
The global ratings agency Moody's Investors Service sharply cut its FY20 GDP growth forecast for India to 5.8 percent. The World Bank forecasts the growth at 6% in FY-20 with a gradual increase to 7.2% by FY22 on the assumptions that the RBI provides the needed monetary support and the inflation is under control. The International Monetary Fund (IMF) referred to the slower growth as cyclical weakness and revised its estimate to 6.1% (from 7% projected in July). Similar was the projections done by other agencies like ADB at 6.5%, OECD at 5.9%. While the agencies may not have the same growth projections and expectation on recovery timeline, the consistent message is downward growth trend for the economy.
Over the last few months, the Government showcased anecdotal evidence (e.g turnover of box-office hit movie, meeting between industry leaders and the Finance Minister) to substantiate the continued growth theory (though lower than 8% as earlier predicted) – barring some sectoral issues in automotive and a few ones. While the slowdown has been acknowledged recently by the Finance Minister in Parliament (Nov 28), she claims that this is not a recession (i.e. negative growth in 3 consecutive quarters) and is not going to be.
Niti Ayog Vice Chairman Rajiv Kumar claims (October 2019) the economy to ride on 6.5% growth in FY20. RBI is possibly more rational to lower growth to 6.1% for FY20. The Chief Economic Advisor claims “that the fundamentals of the Indian economy continue to be strong and GDP is expected pick in Q3” but this is unlikely to excite the business and the opposition. It will be interesting to see how the GDP growth reaches the desired level in FY20 after registering less than 5% growth in first 2 quarters of the year.
The debate whether this slower growth is structural or cyclical has relevance as this may predict time and extent of recovery in short and medium run. Slowdown due to structural reasons is of bigger concern as the underlying issues are often difficult to identify and address. The cyclical changes are likely to recover as we have seen the patches of some slowdown over the last few decades.
A working paper by NIPFP (Pandey, Patnaik and Shah, Jan 2018) has analysed the cyclical growth pattern in 2 separate time-periods : 1950 – 1991 (when policy environment was characterised by restrictions to private sector growth and foreign investment) and post liberalisation era of 1991 onwards. The paper argues that the economic fluctuations in first period were driven by agricultural fluctuations and oil price shocks. The more conventional business cycles were seen during post 1991 period when private sector and foreign investment participation were opened and increased over time. According to the authors, there were 3 periods of deceleration: Q4-1999 to Q1-2003, Q3-2007 to Q3-2009 and Q3-2011 to Q4-2012 and deceleration was visible in a number of key indicators such as investment, credit growth, exports and firm performance indicators. Due to introduction of new series with 2011-12 (from 2004-05) as base for GDP and a different measurement approach, it is difficult to continue the same analysis for the period beyond 2012. But a reflection on some of the above parameters may be worth looking into in the current context.
Low Consumer demand & Poor Manufacturing Performance
The demand in the economy are generated primarily from private, industry, government and export. The major demand that fuelled the growth is final consumption expenditure – both of private (PFCE) and government (GFCE) sectors. PFCE which reflects the demand in the economy, grew at 3.14% in Q1-20 vis-à-vis 7.3% in Q1-19 (and 10.6% in Q4-18). The share of PFCE in GDP also showed a decline from 58.7% in Q1-19 to 57.7% in Q1-20. According to RBI Survey (Oct 2019), PFCE, however, is expected to improve to 7% during 2020-21.
RBI survey also cites low consumer confidence as sentiment around employment, income and discretionary spending declined and that is reflected in both the current situation index and the future expectations. The Current Situation Index (CCI) fell into 89.4 in September from 95.7 recorded in the July round of survey, the data showed. This has a spiral impact on the growth of production – especially consumer durables. FMCG sector, however, continues to show better performance.
The said lowering of consumer expenditure alongwith the lower consumer sentiment have slowed the demand in the economy and have a negative impact on the industry and industrial production. A sharp contraction in industrial production also showed continuing stress in the consumer goods sector. The output of consumer durables and consumer non-durables fell 9.9% and 0.4% respectively, according to the Ministry of Statistics and Programme Implementation (MOSPI). Even the bank credit on consumer durables shrank 13.6% in the financial year so far, going by the RBI data.
The lower demand made its adverse impact on capacity utilization in India’s manufacturing sector that recorded its worst since 2008 with a decline by 6 percentage points in 6 months (69% in Q2 FY20 from 76% in Q4-FY19). The lower capacity utilization in Cement, Steel actually reflects the lowering of demand or investment in the infrastructure sector.
Slow Export Growth & Import
While the domestic demand shows a decline, the export demand also followed the suit. India’s export recorded $26 bn in Nov 2019. As the manufacturing and consumer demand slows down, the imports recorded decline of 12.7% from last year and stands at $38.1 bn in Nov. Thus, India recorded a deficit of $12.1 bn in Nov 2019. During the first 7 months of the fiscal (April-October), exports have contracted 2.2%, while imports shrank 8.4% leading to a trade deficit of $95 billion.
It’s a fact that escalating trade tensions and a slowing global economy have also been responsible for the slow export growth. In fact, WTO has downgraded its trade growth forecast sharply for 2019 and 2020. However, the weakened external sector would continue to cause an additional challenge for India to boost its demand.
The current economy slowdown would require impetus to boost the demand that in turn increase the production. Lets look at the incentives that the Government has been planning or providing to enhance the demand. The measures are focussing more on supply side push to create and trigger demand through income and employment generation.
Rate cut by RBI
The Reserve Bank of India cut interest rates for the fifth time in a row in early October in an attempt to give a renewed push to a slowing economy and said it will maintain an accommodative policy stance until growth revives.
The rate cuts are expected to generate additional demand from consumers for key sectors like auto, real estate etc and also to make investment cheaper for industry to invest in. Data reveals that these two key sectors have not shown the improvement in growth – barring temporary period of festive seasons. Moreover, RBI has already slashed 135 basis points since January without any improvement in growth and we have been witnessing sudden spike in retail inflation in recent months.
Source: Paisabazar.com
Reduction of Corporate Tax
In September, the Finance Minister announced a reduction in the country’s effective corporate tax rate from around 35% to 25%. For companies that do not avail of any other incentive or commission, the effective tax rate would be just 22%.
The expectation is to encourage higher production by the industry as they anticipate higher profit from the tax cuts. What is not clear why the industry (auto, for example) that is suffering from lower consumer demand would produce more and how this measure is going to help enhance the consumer demand. On the contrary, this may create avenues for the companies to make higher profit from the same investment and may trigger more inequality in the economy.
The move that will forego annual revenue of Rs 1.45 lakh crores is expected to increase the fiscal deficit to 4% in FY20 (vis-à-vis the target of 3.3%). India's fiscal deficit, an indicator of borrowings by the government for financing its expenditures, has already surpassed the annual target within the first 7 months (April- October) of the current financial year and stood at Rs 7.2 trillion ($100.32 billion) or 102.4% of the annual budgeted target.
Increase in government spending & Fiscal Deficit
Overall government expenditure in FY18 and FY19 went up by 15% and 9.3% (adjusted for inflation) respectively, at a time the economy was growing by 7.2% and 6.8%, respectively. Over the last couple of years, the jump in government expenditure has kept growth going. It is interesting that the economy grew by 5%, private consumption expenditure went up just 3.1% and government spending grew 8.9% in this year.
The higher fiscal deficit is expected to slow down the government expenditure – if the budgeted fiscal deficit is to be maintained. The government expenditure in H1-FY20 stands at 53.4% of the full year budget and to manage the same within the budget implies lowering of the government expenditure – another impetus for the demand (and potentially growth). In other words, while the government needs more money to spend, the government is not earning enough through tax revenue as per the budget target for FY20. If the government expenditure needs to match budget value, the gross tax revenue needs to rise by 18.3%. The gross tax revenue between April and August has grown just 4.2% implying significant slower growth in tax revenue. In fact, this is reflected in GST collection that has collapsed – an indication of low consumer demand.
The government may need to continue the expenditure (including higher capital expenditure, to be more specific) and for a temporary period, compromise on a little higher fiscal deficit to boost the economy. While this may have a tendency to push inflation temporarily, the same has been under control for a long time (except for recent surge). The economy would need demand push – the approach of the government has been to boost the economy primarily through indirect means (rate cuts, tax cuts) over the last 9 months. The economy would warrant a further direct push.
Can we boost the economy’s demand beyond these measures? One of the hypotheses is to transfer cash directly to the target consumer segments who can potentially increase the demand directly. Over the 5.5 years of the current government has focused in redistribution – as much like its predecessor government. Jan Dhan Yojana, Ujjwala yojana, Swachh Bharat, Ayashman Bharat, Mudra Yojana, NREGA exist for redistribution of government money for various purposes. Needless to say, this is beside the subsidy program of various types catering to sometime overlapping. In 2019-20, the total expenditure on subsidies, as per the central budget, is estimated to grow to Rs 3.39 Lakh crore - 13.3% increase over the revised estimate of 2018-19.
While we understand the political agenda for elections and also the social and development agenda in focussed areas that have driven these measures, the impact on public exchequer is significant and in the current situation, is not significantly impacting growth.
The government may consider consolidation of the outflow on select categories of expenditure including subsidies and redistribute cash transfer to the target group. The target group may include the rural (and urban) low income population that has, over the past years, pushed consumer demand to enhance growth. This is expected to generate demand in the consumer goods due to higher propensity to consumption of this set of population. This is expected to enhance demand that the economy is currently struggling to achieve. Understandably, the execution of this scheme needs to overcome challenges – identifying target group, reaching and distribution mechanisms etc. While those can be worked out alongwith the economic mechanism of gathering resources (through fiscal means and/or consolidation of subsidies), will we have a political agenda to drive this? With tough decisions taken by the government in social and political aspects in recent past, it is time to take some tough ones in economic front.
(The view expressed by the author is personal)
Economics of India’s Slowing Economy: Need for Demand Push?
(December 2019)
Rethink