Context

Domestic demand must play a greater role in India’s growth story.

Recovery in the Indian economy

• Sub-5 per cent growth rate: India’s fourth-quarter GDP growth (the calendar year 2019) printed another sub-5 per cent growth rate.
• Favourable base effect: It would have been lower had it not been for the large downward revisions to previous years’ GDP that statistically boosted the last quarter’s growth rate because of favourable base effects.
• The decline in GDP stabilised: Policymakers and the market heaved a sigh of relief that the relentless decline over the last three years at least seems to have stabilised around 4-5 per cent.
• Why some countries prefer sequential growth rate: Because year-over growth rates are so strongly affected by what happened a year ago, most economies (including China) instead publish and conduct policy discussions based on sequential quarterly growth.
  • Better sense of momentum: Sequential growth rates provide a much better sense of the momentum and turning points in activity, which are critical to deciding whether, how much, and when the economy needs policy support.
• The magnitude of recovery: The growth momentum rose, albeit modestly, from 3.8 per cent in the third quarter of 2019 to 4.1 per cent.
  • Non-farm and non-governmental GDP recovery: More importantly, non-farm and non-government GDP (the closest approximation to non-farm private-sector GDP) bounced much more sharply from 1.6 per cent (and no this is not a misprint) to 4.4 per cent in the fourth quarter.

What is the dominant narrative of the slide in growth?

• The deceleration in sequential terms: With the revised data, we now know that annual growth over the last four years has slowed from 8.3 per cent to 7 per cent to 6.1 per cent to 4-5 per cent.
  • The decline in non-farm private GDP: In sequential terms, the deceleration was far more dramatic, especially in non-farm private GDP, which after hitting a run rate of 13 per cent in the first quarter of 2016 fell to 1.6 per cent by the third quarter of 2019.
  • The dominant narrative of the cause of slide: The dominant narrative is that India’s woes are just an unfortunate and unintended consequence of demonetisation, the shift to a national GST, and the credit squeeze caused by the bad debt in banks and non-banks.
  • The dominant narrative on recovery: With a bit more fiscal support, some monetary easing, and extended regulatory forbearance to help banks work out their bad debts, these headwinds will fade and India will likely be back to its winning ways.

Why real cause of the slowdown lays somewhere else?

Following factors suggest that answer lies somewhere else.

• Disruptive but not the drivers of the slowdown: While it is undeniable that facts stated in the dominant narrative had been disruptive, they couldn’t be the drivers of the decline.
  • Slide in growth started even before demonetisation: India’s growth had been sliding since the second quarter of 2016; nearly 6 months before demonetisation and a year before the GST was introduced.
  • By the third quarter of 2016, non-farm private sector growth had already slid to 3.5 per cent.
  • Bad debt problem predates slowdown: Although bad debt hit the headlines in 2016, the overleverage had already begun to tighten bank lending since 2014.
• Fall in corporate investment- inexplicable cause: More inexplicable is the argument that falling corporate investment is the main culprit for the slowdown.
  • It is true that corporate investment is no longer running at the heady 17 per cent of GDP of the pre-global financial crisis (GFC) days but at a much more sombre 11-12 per cent.
  • However, this outsized adjustment had already taken place by 2010 and since then, corporate investment has flatlined at current levels.

The answer lies in globalisation

It is obvious once one eschews India’s exceptionalism and accepts that it is just another emerging market economy that grew on the coattails of globalisation with the minimal reforms. Globalisation has largely determined India’s fate.

• Growth in corporate investment and exports: Contrary to a widely held misperception, India is and has been for a long time far more open to the global economy than believed.
  • Rise in corporate investment from 5 to 17%: The limited liberalisation of 1991-92, coupled with the corporate restructuring in the late 1990s, spurred corporate investment to rise from 5-6 per cent of GDP in the early 2000s to 17 per cent of GDP by 2008.
  • Increase in exports: Almost all of this expansion in investment was geared to produce for exports, which grew at an astonishing pace of 18 per cent per year-over-year in this period as global trade expanded at breakneck speed with the entry of China into the WTO in 2001.
  • 12% of GDP to 26% of GDP: Exports as a share of GDP more than doubled from 12 per cent in the early 2000s to over 26 per cent by 2008.
  • Slow growth in private consumption: In contrast, private domestic consumption, which is considered to be India’s great strength, grew only at 6 per cent annually, less than the growth rate of the economy, such that its share in GDP fell from 63 per cent to 56 per cent.
  • The engine of the Indian economy- Export: Since 2012, global trade has floundered and with that so has India’s economy.
  • Indeed, the entire rise and fall of investment, including the quarter-to-quarter twists and turns in it, can be almost fully explained by changes in exports.
  • The Indian economy has long been flying on one engine – exports — and that is now spluttering.

What are the prospects of taking the economy back to its high growth path

• Unlikely: So will the nascent recovery strengthen and take the economy back to its high growth path? Unlikely on current policies.
• COVID-19 factor: In the near term, as in now widely feared, the COVID-19 outbreak could turn into a pandemic, sharply reducing global demand and trade.
  • With that, even expectations of a modest 2019-20 recovery to 5.25 per cent growth are under threat.
• Backlash against globalisation: Over the longer term, it is unlikely that global trade will return to its pre-Global financial crisis growth rates not only because supply chains have stopped expanding in the absence of any material technology breakthrough, but there is also a growing political backlash against globalisation in the developed market that has led to increased trade barriers.

Way forward

• Search for new sources of growth: India too, like other emerging market economies, needs to face up to the reality that it can no longer depend on global trade to be the only growth driver. Instead, it needs to search and find new sources of growth and that starts with recognising and accepting reality.
• Let domestic demand play a greater role in the economy: Policymakers need to stop thinking about India as a perennially supply-constrained economy focusing almost all policies and reforms to easing these constraints. Instead, it is time to let domestic demand play a greater role in India’s growth story.
• Policy changes: The above factors mean that India Inc. needs to shift from producing what foreigners want to produce what residents can afford, it also means that policymakers have to reverse policies that have so far forced households to keep increasing savings (for retirement income, children’s education, healthcare, and housing) through a web of financial repression, regulatory distortions, and public spending choices.
  • It means redesigning India’s infrastructure to look more inward and less outward.
  • Reduce out of pocket expenses: Increasing public provisioning of healthcare and education, reforming insurance regulations to reduce out-of-pocket expenses and eliminating financial repression to raise returns on retirement savings.
  • Merely tinkering with macroeconomic policies will not be enough.

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Context

The focus in the near future should to increase investments and facilitate credit for funding these productive assets so that India’s potential output growth can steadily rise.

Growth prospects of India

• The NSO forecast at 5%: The latest data from the National Statistical Office (NSO) retained India’s economic growth forecast at 5 per cent for the current financial year.
  • Growth has dropped from 6.1 per cent in the previous year.
• Fall in nominal GDP: More strikingly, nominal GDP growth has decelerated from an average of 11 per cent during 2016-17 to 2018-19 to 7.5 per cent this year.
  • Lower inflation added to the volume slowdown.
  • The value of India’s GDP for FY20 is estimated at around $2.9 trillion.

Input and output side growth prospects

• GDP is estimated from both output and demand lenses, using specific economic indicators as proxies for activity in specific sectors.
• Output side: From the output side, sector-wise estimates were as following-
  • Agriculture sector growth was revised up to 3.7 per cent (up from the 2.8 per cent previously).
  • Agricultural production is expected to improve based on the third advance estimates of the rabi season crops, as well as higher horticulture and allied sector output (livestock, forestry and fishing), which now is significantly larger than conventional food crops.
  • Industrial activity was lowered to 1.5 per cent (from 2.3 per cent earlier).
  • The key concern regarding the continuing slowdown is the increasing weakness in the industrial sector (particularly of manufacturing, whose growth has progressively fallen from 13.1 per cent in FY16 to 5.7 per cent in FY19, and plummeting to 0.9 per cent in FY20).
  • Services output remained largely unchanged at 6.5 per cent.
• Demand-side: From a demand perspective, the obverse side to the manufacturing slowdown is the even sharper drop in fixed asset investment growth — down sharply from an average 8.5 per cent during FY17 and FY19 to -0.6 per cent in FY20.
  • The causes for this contraction needs to be understood in detail, and we will return to this.

Private consumption- a significant driver of growth

• Private consumption at 60% of GDP: The other significant driver of growth in India has been private consumption. For perspective, the share of private consumption had averaged 59-60 per cent during FY16-FY20.
• Government consumption 10% of GDP: Reflecting the higher spending over the last couple of years, the share of government consumption in GDP has risen from an average of 10.5 per cent of GDP over FY12-17 to almost 12 per cent in FY20, resulting in the share of total consumption above 70 per cent.

Drop in the share of nominal investment

• Drop from 39 % to 30 % of GDP: The really remarkable trend, though, as noted above, is the share of nominal investment in GDP progressively dropping from 39 per cent in FY12 to 30 per cent in FY20.
• Is it a good sign? Part of this is actually good, reflecting higher Capex efficiency.
  • Slowing household consumption: One narrative underlying the contraction in fresh Capex in FY20 was slowing household consumption growth, which, in nominal terms, fell from an average 11.6 per cent during FY16-19 to an estimated 9.1 per cent in FY20.
  • Disproportionate contribution to lower growth: Though the deceleration prima facie does not seem significant enough to result in a broader economic slowdown of the current magnitude, the high share of household consumption has contributed disproportionately to lower growth.
  • Fall in capacity utilisation: A direct fallout of this is that seasonally adjusted capacity utilisation (based on RBI surveys) had shrunk from 73.4 per cent in the first quarter of FY20 to 70.3 per cent in the second quarter, and this is unlikely to have improved materially in the second half of the year.
  • This is one of the reasons for the low levels of fresh investment.

Reduced flow of credit to the commercial sector

• Impediment to growth revival: The other cause of the low Capex, more from the supply side, is a much-reduced flow of credit to the commercial sector, and this remains the proximate impediment for growth revival, with signs of risk aversion in lending still strong despite the recent measures by RBI to incentivise credit to productive sectors.
  • Funds from selected sources, over April-January FY20, was only about Rs 9 lakh crore as against Rs 15 lakh crore in the corresponding 10 months of FY19.
• Bank credit lowest in three months: Growth in bank credit (which is still the largest source of financing) till mid-February 2020 was down to 6.3 per cent — the lowest in three years.
  • Even this is almost wholly driven by retail credit; incremental credit to industry and services over this period was negative.

Investor confidence and coronavirus factor

• A bright feature of the economic environment: One bright feature in this economic environment is strong foreign investor confidence in India, reflected in both FPI equity and FDI flows.
  • Many borrowers have used offshore sources to refinance or pay down domestic bank loans and debt.
  • A global risk-off environment might restrict even this channel in the near future.
• Robust corporate bond issuances: Domestic corporate bond issuances have also remained robust, although the dominant set of borrowers still remain public sector agencies and financial institutions.
• Coronavirus factor likely to moderate the gains: Monthly economic indicators suggest that the growth deceleration has likely bottomed out in the third quarter.
  • The bet has been on reducing inventories and the consequent production ramp-up to replenish stocks. However, the evidence on this is mixed.
  • The coronavirus effects, both concurrent and lagged, will also moderate some of the emerging positive effects of counter-cyclical policy measures of the past six months.
  • If the outbreak does not abate over the next month or so, the complex supply chains of intermediates sourced from China will run dry and add to the already weak system demand.
• Growth prospects in the next few weeks: Surveys indicate that both business and consumer confidence, which while improving, remain muted. A growth revival, hence, is likely to be only very modest over the next few quarters.

Conclusion

A $5 trillion economy by 2025 is still a worthwhile target and aspirational; coordinated strategies, policies, execution and institutional mechanisms will be needed to move up to a sustained 8 per cent plus growth consistent with achieving the target. The focus in the near future should to increase investments and facilitate credit for funding these productive assets so that India’s potential output growth can steadily rise.

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