The growth in the quarter from July to September had slipped to 4.5%. This was the lowest level recorded in six-and-a-half years, with the 6.1% nominal GDP growth (real growth plus inflation) coming in as the slowest in a decade.
- The International Monetary Fund (IMF) had already pared India’s growth estimate for this year to 6.1% in October from its earlier forecast of 7%, but is now expected to slash it further with the country in the midst of a significant economic slowdown”.
- Is this slowdown a result of a cyclical phenomenon or has it been driven by a structural malaise arising from deficiencies in the economic framework?
What Is an Economic Slowdown?
- An economic slowdown occurs when the rate of economic growth slows in an economy.
- The rate of economic growth or decline is calculated by determining the percentage change in GDP from one period to another.
- For example, the value of a country's GDP in the second quarter of this year may have increased by 2% in value from the first-quarter GDP.
- However, if the GDP rose only 1.5?tween the second quarter and the third quarter, we can say that the economy is slowing down because it is not growing as fast.
What is a cyclical slowdown?
- The economic growth of any country is driven by a virtuous cycle of savings, investment and exports.
- A cyclical slowdown is a period of lean economic activity that occurs at regular intervals. Such slowdowns last over the short-to-medium term and are based on the changes in the business cycle.
- Generally, interim fiscal and monetary measures, temporary recapitalisation of credit markets, and need-based regulatory changes are required to revive the economy.
What is a structural slowdown?
- A structural slowdown, on the other hand, is a more deep-rooted phenomenon that occurs due to a one-off shift from an existing paradigm.
- The changes, which last over a long-term, are driven by disruptive technologies, changing demographics, and/or change in consumer behaviour.
- In such a scenario, a monetary and fiscal stimulus won't be enough to revive the economy. Fixing such problems would require the government to undertake some structural policies.
- The best example in this regard would be the reforms that were carried out to address the crisis in 1991.
What the economic data says
Comparing indicators for the first seven months of this financial year with the past, there is an indication that the current slowdown is closer in nature to what was faced as far back as 1991 — the year India liberalised.
- A slow and steady dip in growth: Compared to the previous quarter when growth clocked 5%, the 4.5% rate was not a dramatic downswing, but capped off a slow and steady dip in growth over six quarters in a row.
- Fixed investment slumped to 1%, private consumption growth halved year on year, and manufacturing activity contracted by 1%.
- Industrial output shrank 3.8% in October, the second straight month of contraction belying expectations that festive demand may revitalise production activity.
- Falling exports: In September, India’s trade deficit slipped to a seven-month low of $10.9 billion as exports and imports witnessed the steepest fall in three years. Merchandise exports shrank 6.57% to $26 billion, while imports dropped 13.9% to $36.9 billion.
- The 12.2?cline in electricity generation: Electricity generation is a good barometer of demand generated by all economic activity, not just industrial production. Less economic activity less will be electricity generated.
- The GST revenue during September 2019 has declined by 2.67% in comparison to the revenue during September 2018.
- Although for November, Goods and Services Tax (GST) collections crossed ₹1,03,000 crore. It remains to be seen if this can be sustained.
- The mess in the credit system: It reflects both the overhang of bad debts of banks and the erosion of non-banks after the collapse of the aggressive lender, Infrastructure Leasing & Financial Services Limited. Bank credit growth is expected to hit a 58-year low in 2019-2020.
- High Retail & Food inflation - Retail inflation has hit a 40-month high of 5.54% in November, more than double the 2.3% recorded a year ago. Food inflation hit 10%, led by vegetables (think of onions) and pulses.
- Falling tax revenues: In 2018-19, tax revenue was short by about ₹1.5 lakh crore. But this was not reflected in the planning for the 2019-20 Budget. The revenue shortfall for the Centre for 2019-20 will be even larger than last year — around ₹2 lakh crore.
- Gross Fixed Capital Formation (GFCF) relative to GDP at current prices: a steady fall has been visible in GFCF since 2011-12 when it was 34.3%. Assuming an Incremental Capital Output Ratio (ICOR) of 4, this meant a fall of nearly 1.4% points in the potential growth rate.
The economic growth of any country is driven by a virtuous cycle of savings, investment and exports. Of all the three, investment is considered to be the key driver of growth. To quote the Economic Survey (2019), investment, especially private investment, is the 'key driver' that drives demand, creates capacity, increases labour productivity, introduces new technology, allows creative destruction, and generates jobs. The investment rate as measured by Gross Fixed Capital Formation (GFCF) as a per cent of GDP is showing a declining trend.
- Fall in household savings rate: Savings by household sector – which are used to extend loans for investment – have gone down from 35% (FY12) to 17.2% (FY18). Households, including MSMEs, make 23.6% of the total savings in the GDP.
- The dismal state of the rural health sector has already been revealed in the Economic Survey 2018-19. About 60 per cent of the Primary Health Centres have only one doctor while 5 per cent have none. Only 20 per cent fulfil Indian Public Health standard norm. With meagre spending on healthcare, how does the government hope for a rise in labour productivity?
- Unemployment crisis: The National Sample Survey Office’s (NSSO) job survey for the year 2017-18 had shown a jump in the unemployment rate to over 6 per cent, a 45-year high.
Worries about India entering a phase of stagflation, where growth and employment are low but inflation is high. Any further spike in inflation, that makes it closer to or over the Reserve Bank of India’s (RBI’s) tolerance limit of 6%, will take the option of cutting interest rates for spurring growth out of the equation.
Is the slowdown structural or cyclic?
- Mr Subramanian, the ex-Economic advisor, reckons that Demonetization and GST may have hurt growth, but cannot be the reason for the precipitous fall in recent quarters. India’s current crisis is driven by both cyclical and structural factors — but problems in finance have exacerbated the slowdown.
Analysing the slowdown
India’s current economic slowdown is due to a combination of two underlying trends.
- There is the short-run cyclical slowdown due to significant fall in demand for automobiles, consumer durables and housing.
- There is the more serious structural slowdown of long-term fall in investment and savings rates.
Structural reasons for an economic slowdown
Jobless growth: The increasing inequality associated with jobless growth meant that mass consumption demand did not rise as expected with rapid GDP growth.
Impact of demonetisation:
- Small businesses and the MSME sector badly hit: The Centre for Monitoring Indian Economy reported that 1.5 million jobs were lost in the unorganised sector during January-April 2017, just after demonetisation. This led to reverse migration to villages. This further led to a substantial increase in demand for MNREGA work.
- Agriculture runs mainly on cash and is mostly tax-exempt. The farm economy was hit by the sudden withdrawal of cash from the system during demonetisation.
Hasty implementation of GST: Sourcing from MSMEs took a hit as bigger companies preferred to purchase from suppliers who could provide GST receipts.
Structural issues with GST
- The multiplicity of tax rates
- High tax rates on automobiles, and building and construction material caused a further slowdown in these sectors.
- By excluding petroleum products, real estate and electricity, 40% of the internal indirect taxes at the Centre as well as states are not in the net.
- The originally proposed three forms, GSTR-1, GSTR-2 and GSTR-3B, could not be operationalized.
Cyclical reasons for the slowdown: low growth is further damaging balance sheets, and deteriorating balance sheets are bringing down growth.
The 2008 global financial crisis: The first wave — the Twin Balance Sheet crisis, encompassing banks and infrastructure companies — arrived after the global financial crisis. These problems were not addressed adequately.
The collapse of IL&FS in late 2018: The second wave came from the collapse of a credit boom, led by NBFCs, and centred on the real estate sector. The IL&FS default was also a result of the delay in the rolling out of various infrastructure projects. As a result, the economy now confronts a Four Balance Sheet (FBS) problem — the original two sectors, plus NBFCs and real estate companies.
Falling investments: Gross Fixed Capital Formation (GFCF) as a per cent of GDP is showing a declining trend.
Falling gross domestic savings as a per cent of GDP which declined from 32.7 per cent in 2011 to 29.3 per cent in 2018.
Falling exports: During the same period, exports as a per cent of GDP also declined from 24.5 per cent to 19.6 per cent.
Declining savings due to the decline in wage growth: Rural wage growth has declined from 27.7 per cent in FY14 to less than 5 per cent in FY19. The corporate wages have also exhibited a single-digit growth in FY19 compared to a double-digit growth a few years back.
Declining consumption: Declining sales and piling inventories are forcing companies to cut down production. The cutting down of production has driven the unemployment rate from 5.6 per cent in July 2018, to 7.5 per cent in July 2019.
A longer period of low inflation rate: It has declined from 10.03 per cent in FY13 to 3.41 per cent in FY19. The low inflation rate would be a relief to the consumers, but a prolonged period of falling prices depicts weakening of demand that would discourage fresh investments and job creation.
- Crowding out of private sector: government ‘s borrowing is crowding out private investment.
- NPA crisis: The gross non-performing asset ratio of banks may increase to 9.9 per cent by September 2020 from 9.3 per cent in September 2019, according to a Reserve Bank of India (RBI) report. It has led to banks shying away from lending.
Policy related slowdown :
- With the collapse of new projects and many existing ones getting stuck after the introduction of the Real Estate Regulation Act, or RERA,
- Anti-pollution BS-VI norms are putting the burden on the automobile sector.
- Ailing telecom sector: A Supreme Court decision backing the telecom department’s stance on including revenues from non-core items in the definition of adjusted gross revenue (AGR) while calculating government levies, has put a Rs 1.3 lakh crore burden on telecom companies.
Govt. initiatives to check slowdown:
- National Infrastructure Pipeline (NIP): the government has identified sectors such as power, railways, urban, irrigation, mobility, education, digital and health sectors for bulk Rs 105-lakh-crore investment under NIP.
- These projects are over and above the Rs 51 lakh crore spent by the centre and the states in the last six years.
- The Centre and states' contribution to the National Infrastructure Pipeline (NIP) would be 39 per cent each as well as 22 per cent by the private sector. The govt. expected the share of the private sector to increase to 30 per cent by 2025.
- Under NIP the government has also identified Rs 2.5 lakh crore port and airport projects, Rs 3.2 lakh crore digital infra projects, Rs 16 lakh crore irrigation, rural, agri and food processing projects, and over Rs 16 lakh crore infra projects including mobility projects.
- Reduction in the corporate tax: Base corporate tax for existing companies has been reduced to 22 per cent from 30 per cent, and to 15 per cent from 25 per cent for new manufacturing firms incorporated after October 1, 2019, and starting operations before March 31, 2023. It will support the business environment and competitiveness.
- Bank Mergers: The government has unveiled a mega plan to merge 10 public sector banks into four as part of plans to create fewer and stronger global-sized lenders. The merger of public sector banks can help streamline and strengthen the banking sector.
- Disinvestment: The government kicked off a blockbuster disinvestment plan, lining up the sale of five public sector units (PSUs), including majority stakes in bluechip oil company Bharat Petroleum Corp Ltd (BPCL) and Shipping Corporation of India. Also on sale will be a 31% stake in Container Corporation of India (Concor) along with management control.
- Bank Recapitalisation: The Union government will infuse Rs 70,000 crore into public sector banks (PSBs) in 2019-20 to strengthen and enhance their lending capacity.
- Recapitalisation will involve two legs — first, banks will subscribe to bonds floated by the government.
- In the second leg of the government will infuse that money into public sector banks, bankers said. The same method was adopted last year for giving capital to banks.
- Rs 70,000 crore package for the exports and real estate sectors, including setting up of a stressed asset fund, as the government continued with firefighting measures to pull the economy out of a six-year low growth rate.
- Repo Rate reduction: For the fifth consecutive time this calendar year, the central bank cut the repo rate by 25 bps and the reverse repo by 25 bps (100 bps = 1 per cent).
- RBI carried out the first phase of 'Operation Twist', when it sold short-term securities worth Rs 10,000 crore and bought long-term securities worth the same value. This operation involves buying and selling government securities simultaneously in order to bring down long-term interest rates and bolster short-term rates.
- Measures for better transmission of changes in policy rates: All the floating rate loans of banks, effective April 2019, shall be benchmarked to an external rate, like the RBI repo rate or the yield on Government of India Treasury bills.
- Insolvency and Bankruptcy Code (Amendment) Act 2019: Government has amended IBC to ensure timely admission of insolvency cases and completion within the newly set deadline of 330 days (it was 270 days earlier). The resolution plan under the corporate insolvency resolution process will also be binding on the Centre, State and local authorities.
- Codification of labour laws: The Labour Ministry is in the process of codifying the 44 central Labour Laws that exist at present in 4 labour codes. The four codes include — Code on Wages, Code on industrial relations, Code on social security and Code on safety, health and working conditions. It will increase the ease of doing business.
Sector Wise intervention:
- Enhanced surcharge on FPIs withdrawn.
- Future GST refunds to be paid in 60 days.
- Simplification of the GST system to be done
- Prepayment notices issued to NBFCs to be monitored by banks.
- Support to Housing Finance Companies by the National Housing Board increased to Rs 30,000 crore.
- Rs 70,000 crore upfront for PSBs recapitalisation.
For Home & auto loans
- Banks to launch Repo Rate linked loans.
- Online tracking system for home, auto loans.
- PSBs to return loan documents to customers within 15 days of loan closure.
For the Auto industry
- BS-IV cars purchased till March 2020 to remain operational for the entire period of registration.
- Govt to replace old vehicles with new vehicles.
- Higher vehicle registration fee postponed.
- Depreciation increased to 30 per cent for all vehicles purchased till March 2020.
- Govt. withdraws angle tax provision for startups.
- One-time settlement policy for MSME loans.
- Amendment of laws to ensure one MSME definition.
For the Telecom sector
- Telcos have been given a two-year moratorium (from spectrum payment), giving a relief of ₹42,000 crores,
For the FPI sector
- The rollback of the capital gains tax imposed in the budget on foreign portfolio investors.
- Withdrawal of angel tax on start-ups.
- Non-compliance with corporate social responsibility (CSR) norms will be decriminalised.
For Income Tax
- Govt to end tax harassment.
- From October 1, 2019, all Income Tax notices must be disposed of within 3 months.
Challenges: Both Looming & Ahead
- Low savings leading to higher interest rates: These savings have now reached a level which isn’t adequate to fund the government borrowings.
- Monetary policy seems to be less effective than fiscal policy as ‘improper transmission mechanism’ fails to pass on benefits to the real economy.
- Liquidity is turning into insolvency: NBFCs are in crisis. It's not just the government and the private sector, within the private sector, nobody wants to lend to anybody else.
- The room for tax cuts is very limited: GST collections this year have also been tepid and below target, leaving little room for the Centre to spend its way out of trouble. Stoking of inflationary pressures also need to be avoided.
- MSME problems: The growing incidence of sickness of the sector apart from non-availability of authentic financial data, vulnerability on account of delayed payments by buyers, technological challenges due to low awareness, absence of single MSME data repository, low awareness about various government initiatives and lack of compliance to statutory, legal, environmental norms are some of the issues that MSMEs are struggling with.
- Telecom sector’s stress: The telecom industry is reeling under a debt of over ₹4 lakh crore. It is also suffering losses due to price wars.
- GST frauds and delays: So far, 9,385 cases of tax fraud by this means have been detected involving an amount of ₹45,682 crores.
- In addition, the dysfunctional technology platform has caused delays in the refunds to exporters.
- Shortfall indirect tax collections: This is both the result of corporate tax concessions and the slowing economy.
- Skill gap: While millions wait for jobs, industries have huge gaps in manpower as the skill sets are not available.
- Rising fiscal deficits: The Centre and the States are so short of resources that their fiscal deficit is burgeoning.
- Court-induced delays and economic damage: The delay in two recent court decisions—on the calculation of telecom companies’ adjusted gross revenues (AGR), which form the basis for working out revenues due to the government, and Essar Steel case—have bloated the project costs.
- GST compensation: A recently released RBI report indicated that the effective GST rate in India has come down to 11.6 per cent from 14 per cent in May 2017, resulting in a reduction in government's revenue to the tune of Rs two lakh crore. This is one of the key reasons which has led to a delay in compensating states.
- Falling GST revenue: For 2017-18, the Comptroller and Auditor General (CAG) of India’s report estimate that the central government part of GST actually declined by 10% for the subsumed taxes as compared to the previous year.
- The loss for states: Concessions in corporate taxation of ₹1.45 lakh crore will mean ₹58,000 crores less revenue for the States.
- Limited Fiscal Manoeuvrability: The Comptroller and Auditor General of India had pulled up the government for deferring the targets under the Fiscal Responsibility and Budget Management Act which it said should have been done through amending the Act.
- Negligible effect of I-T reduction: There is pressure to reduce income-tax rates to boost demand in the economy. But a cut in income-tax rates will largely benefit less than 2% of the citizens who pay a significant amount of income-tax.
- Falling exports: Countries like Bangladesh and Vietnam are fast replacing India in areas it traditionally dominated, for example, ready-made garments.
- The global economy is showing signs of a slowdown: Accordingly, the central banks of major economies seem to be putting a halt on their hawkish monetary policy stance in order to avoid a global recession. It has caused FDI outflow from the developing economies.
- Exports have been hampered as nations are turning protectionist.
Fixing the core crisis afflicting India’s financial entities, creating a sense of certainty and predictability about India’s policy direction, and structural reforms could provide some salve to the bleeding economy.
- Two critical policy moves required:
- First, a countercyclical policy should increase the growth rate to its current potential of 7%-7.5%. Countercyclical steps like tax cuts and higher public spending are required.
- Then structural reforms should raise the potential growth itself to above 8.5% if India is to attain a size of $5 trillion by 2024-25. Reforms in taxation matters labour, land and other restrictive laws are needed.
Immediate Measures to be taken
- More capital expenditure needed: Complementary fiscal stimulus, in the form of additional public sector investment, may prove to be more effective. However, given the fiscal deficit constraint, there is limited flexibility for increasing the centre’s capital expenditure directly.
- Rationalisation of the personal income tax rate: A reduction in personal income tax will hit the government's revenue collection initially, but the move would also provide citizens with more room to spend.
- Urban affordable housing, social housing and infrastructure: House building activity provides employment in numbers. There will be an increase in the demand for steel and cement and this will start a virtuous cycle.
- The banking sector can be pushed to give loans to this sector, if necessary with higher collateral insistence.
- GST reforms: Further reform in GST requires the GST Council to gain confidence in revenue performance and that requires stabilizing the technology platform.
- Conditional financial devolution to states: With the Finance Commission’s award being around the corner, it is an opportune moment to insist on conditionalities to be complied with by the states as a condition precedent to devolution.
- Bringing credibility back to data: The government is working to make sure that any kind of inappropriate methodology to calculate economic data will be addressed gradually.
- Incentivise monetary policy transmission by Banks: The RBI should develop the ability to push money into the hands of the final borrower. For this, RBI needs to incentivize lending to non-banks but consistent with their risk profile.
Medium and long-term interventions
- Infrastructure investment: Roads, water-shed development, logistics chains such as warehouses, cold storage, grading and sorting facilities will not only give succour to agriculture and rural sector but also mitigate rural stress.
- The revitalisation of PPPs with appropriate and enforceable risk allocation will be helpful here.
- A massive increase in rural public expenditure, including in the Mahatma Gandhi National Rural Employment Guarantee Scheme to provide public works as well as in social spending would provide immediate relief.
- Switching to large scale labour-intensive industries: The country will have to switch to large scales labour-intensive industries like textiles, apparels, leather, handlooms and handicrafts should be focused for jumpstart the exports bringing down the trade deficit.
- Investment in the production side of the economy through disinvestment: The stake sales in PSUs and monetisation of land will be helpful.
- Tackling NPAs: A new asset quality review (AQR-2) to get a more honest recognition of the magnitude of stressed assets, and further strengthening the IBC.
- Creation of special resolution mechanisms for two sectors: Real estate and power.
- Investment in the small scale manufacturing: People who are seeking to leave low productivity agriculture – those who are unemployed or under-employed – should be given technical training and be encouraged to set up businesses.
- Implementing Gujral committee recommendations for MSMEs: The Gujral committee had recommended a differential corporate tax regime and tax deduction for export turnover for the MSME exporters for a limited period of five years.
- Labour reforms: Labour reform is required for enabling large scale employment, Similarly, a richer variety of contracts with benefits of social security for workers is required for longer employment.
- Land reforms: Cleaner titles of land, simultaneous land transfer along with registration, technology-based mapping and quicker land subdivision are required for enabling long-term lease of land and ease doing business in agriculture & construction.
- Reducing the high tax burden on telcos and encouraging investments in broadband infrastructure and 5G - The Telecom Regulatory Authority of India (TRAI) may simultaneously examine the merits of a “minimum charge” that operators may charge for voice and data services to curtail their losses.
- Judicial reforms:
- An increasing number of judges: With a huge backlog of cases in the top court, the government had recently increased the strength of its judges from 31 to 34, including the Chief Justice of India.
- Strengthening current mechanisms: There is a need to strengthen the mechanisms like National Mission for Justice Delivery and Legal Reforms, Infrastructure Facilities for Judiciary, e-Courts Mission Mode Project, Strengthening of Access to Justice etc.
- Banks’ privatization: The time is now ripe to bring down the government’s stake below 50% in state-run lenders in order to distance the Centre from banking.
- Reducing health burden: It is not an insurmountable task to have universal healthcare because cutting expenditure in other areas like defence can make funds available for healthcare which is of much more immediate importance.
- Rationalisation of subsidies for energy, water and fertilisers: subsidies are to be withdrawn to have climate-sensitive agriculture and free crop choice. Instead of these subsidies, a DBT transfer to the farmers will take away the likely opposition to the withdrawal of these benefits.
- Skill development: All the industries should be mandated to take in large numbers of apprentices, even if means the government pays part of the internship payment. This will mitigate problems of skilling.
- Aiding the unorganized sector: If the fiscal deficit is allowed to rise further, extra resources can be used to boost incomes in the unorganised sectors through greater public investments.
- Improving banking governance: The need of the hour is to also vastly improve the database and upgrade skills available to the RBI so that analytics can be used to detect common ownership, sectoral exposures, et al.
- Reviving power sector through a Bad bank: a holding company should operate like a public-sector asset rehabilitation agency (a “bad bank”).
Though the present situation in India is not similar to that in 1991, the slowdown is indeed worrying. There is a need to unleash a fresh set of reforms that would help India to achieve the target of a $5 trillion economy.