The slowdown can be attributed largely to a structural demand problem in the economy along with some cyclical factors.
The first advance estimate pegs India’s economic growth at 5 per cent in 2019-20 — the slowest since the global financial crisis of 2008. While one may quibble over whether the actual print may be lower or higher, the cause of the slowdown can be attributed to subdued private consumption and investment activity. And given the current trend of high frequency indicators, not much upside to growth is expected.
The slowdown can be attributed largely to a structural demand problem in the economy along with some cyclical factors. Despite largely stagnant incomes, private consumption, which is the largest driver of growth, has been financed over the past few years through progressively lower savings, easy credit, and certain one-offs such as the Seventh Pay Commission led payouts. The household savings rate has dipped to 17.2 per cent of GDP in FY18, from 22.5 per cent in FY13. And after the recent NBFC crisis, overall credit in the system has dried up as incremental resources from NBFCs to commercial sector were at (-) Rs1.3 trillion in the first half of FY20 compared to Rs 0.9 tn in first half of last year.
The rural economy has been reeling from low wage growth and largely stagnant farmers’ incomes. Rural wage growth has averaged around 4.5 per cent over the past five years, but adjusting for inflation it has been only 0.6 per cent. The rural population, which was dependent on urban real estate/construction has faced headwinds in the recent past with lower private sector investments and a weak real estate sector.
Looking at the key drivers of growth in the short term, there is limited scope for a sharp recovery. The slowdown in private consumption is a structural issue linked to low household income growth. That in turn is linked to the basic problems of low job creation, and stagnant farm incomes. None of these factors are likely to change immediately. Investment is unlikely to rebound sharply given the challenges on both income and balance sheet of the government, private sector, and households. And government consumption, which has been supporting growth over the past few years, remains under stress. The combined Centre and states’ fiscal deficit is close to 6.5 per cent of GDP. Along with an additional 2.0-2.5 per cent of GDP of central PSE borrowings, the public sector is already weighing on the limited domestic financial resources, ruling out space for an aggressive fiscal stimulus.
The government to its credit has shown a clear preference to rely on supply-side measures to support growth. Yet, expectations will be high that the upcoming Union budget addresses the demand side concerns as well. To this end, the government will possibly need to choose between income tax rate reductions, and substantially increasing allocation to the rural sector. Given the narrow income tax base, any sacrifice of the fiscal room would be beneficial only for a limited number of people. Based on filings for the assessment year 2019, out of around 58 million tax filers, only 15 million tax filers had a return income above Rs 0.5 million. Further, the impact on consumption would vary widely depending on the relative gains across income brackets. On the other hand, spending on rural infrastructure and employment (MGNREGA, PM-KISAN, PMGSY) can help alleviate some of the pain in rural areas.
The recovery will depend on the utilisation of the fiscal space, and also the health of the financial sector, especially that of NBFCs. The PSU banks are being nursed back to health, but credit flow from NBFCs to certain segments such as MSMEs needs to pick up.
Addressing India’s long term growth concerns and to push the country into the middle-income group of economies requires a broad-basing of the income and consumption profile. Economic reforms in the past have worked to enhance the capacity of the top few hundred million consumers. The next set of reforms should enhance the capacity of those in the middle and the bottom of the income pyramid.
Further, given the huge infrastructure gap in the country, it is essential that the private sector’s role in infrastructure creation is much more inclusive.
In four key areas of infrastructure — electricity (generation, transmission, and distribution), transport (airports, roads, railways, metros), telecom, and water (irrigation, sanitation, sewage, water supply) — the private sector’s involvement is largely restricted to generation in electricity, inter-city roads, airports in transport, and telecom. The rest are largely in the hands of the Centre, state, and local governments. Policies need to focus on ownership (which is largely government dominated) and pricing (which provides the private sector with a remunerable internal rate of return). It is important to note that creating an enabling environment is to a large extent in the purview of the state and local governments.
Given the degree and nature of the growth slowdown, policymakers should continue to focus on measures that raise the potential growth of the economy. Reforms which increase the productivity of the factors of production, provide an enabling environment for competitive production of goods and services, and ensure steady and substantial growth in purchasing power for a larger section of the population should be the focus. After all, why let a crisis go waste.
This article first appeared in the print edition on January 10, 2020 under the title 'Limited scope for sharp recovery'. The writer is Vice-President and Senior Economist in Kotak Institutional Equities.Views expressed are personal.