The Indian Economy Slowdown- Structural or Cyclical?
With a GDP of $2.97 trillion and growing, India is now the fifth-largest economy in the world behind only the United States, China, Japan, and Germany. Recently, however, there have been concerns over a slowdown in the Indian economy which have been accentuated by weak GDP growth numbers. At a growth rate of 5.8% in the quarter of January to March 2019 and 5% in the quarter of April to June 2019, the Indian economy has entered what economists call a “quasi-recession” i.e. consecutive quarters of GDP growth rate being below the long term average (6.6% in this case). In such a scenario it is imperative to ascertain whether the slowdown is cyclical i.e. simply short-lived, based on the business cycle and correctable by monetary and fiscal stimuli or whether it is structural i.e. a more deep-rooted phenomenon occurring due to a one-off shift from an existing paradigm.
The analysis of a few key indicators such as the cycle of savings, investments, and exports would be a good starting point to unravel the nature of the slowdown. Of these three, investment, especially private investment, is considered the most important metric in driving growth because it increases demand, improves capacity, leads to technological advancement and job creation. Gross Fixed Capital Formation as a percentage of GDP, is used to measure private investment. It has declined from 34.3% in 2011 to 28.8% in 2018. Additionally, new investment projects reduced while the investment projects that were dropped off declined in 2018 relative to that in 2011.
Savings too have seen a downward trajectory with GDP savings as a percent of GDP declining to 29.3% in 2018 from the 2011 value of 32.7%. Compounding fallen from 27.7% in fiscal 2013-14 to sub 5% in fiscal 2018-19 while corporate wages have declined from double-digit growth to single-digit growth. This could be causing the current slowdown in consumption. Unemployment rates rising from 5.6% in July 2018 to 7.5% in July 2019 have only aggravated this problem.
Exports are another indicator of the economy’s health. Official reports state that there has been a 6% year on year decline in exports relative to August 2018 and a 9% decline in the first 5 months of this fiscal year. The depreciating value of the rupee, which has shown a 16% decline in value relative to 2014 has also not helped in the betterment of the situation.
It is not possible to discuss the economic slowdown without mentioning the elephant in the room- the liquidity crisis. On 8th November 2016, the Narendra Modi government decided to demonetize five hundred rupee and thousand-rupee notes post which the economy faced several turbulent quarters with the informal economy taking the worst hit. Just as things began to normalize, the default of a systematically important NBFC, IL&FS shook the economy from its roots. The default caused a domino effect and lenders are now wary of providing funds to NBFCs. This has given rise to a credit crunch and led to the non-availability of funds for consumption and investment. For instance, per the letter written by the Society of Indian Automobile Manufacturers (SIAM) to the Finance Ministry, 70% of all two-wheeler sales and 60% of all commercial vehicle sales are financed by NBFCs. Another group badly impacted are MSMEs who rely heavily on NBFCs for financing and are facing the brunt of the crisis.
A liquidity crisis may be considered a cyclical issue. However, if this was the case then the RBI’s attempt to stimulate the economy through rate cuts would have borne better results. Starting early this year, there have already been four rate cuts bringing the repo rate down from 6.5% in January to 5.4% in August, a cut of 110 bps. However, there has been little impact on the economy primarily
In August, after a few tumultuous months of deliberation, the RBI finally transferred a surplus of rupees 1.76 lakh crore to the government as recommended by the Bimal Jalan Committee. This initially gave rise to hopes of a fiscal stimulus owing to the windfall. However, the target deficit of the government was revised to 3.3% in July earlier this year, down from the earlier target of 3.4% set for 2019-20. In addition to this, GST collections have chronically been missing the targeted figures with August collections once again slipping below the one trillion-rupee mark. As a result, most of the funds received will be dedicated towards fiscal consolidation thereby quashing expectations that the government would take any significant expenditure initiatives to boost the economy.
Conclusion and the Road Ahead
Considering all the above factors it can be inferred that the current slowdown is more than just a cyclical one. Several deeper policy level changes need to be implemented in order to revive the economy. For instance, the IL&FS default was also caused in some part by a delay in the rollout of infrastructure projects. This highlights the need for better land acquisition laws. Another area of contention has been the GST regime. While good in theory, there have been several glitches in its implementation. Multiple tax slabs and the lack of technological readiness at the time of its announcement were some challenges faced. Now, a radical simplification of the tax system, even if it means a short-term revenue loss is required. The agrarian sector is also under distress and requires some stimulus. While certain schemes such as MSP have been put in place, they are insufficient to kickstart rural consumption and revive the sector.
In conclusion, while the causes for concern are more than superficial there are multiple ways in which India can navigate through this slowdown. However, the structural bent of the downturn means that merely slashing interest rates and providing cheap credit to revive the economy will not suffice. The underlying causes of the slowdown call for policy changes and structural reforms like the recent public sector bank merger. These might lead to short term pain but will bear fruit in the long run. Ultimately, it is not the setback but the comeback that will define the long-term trajectory of the country.