On November 29, immediately after the National Statistical Office (NSO) came out with the second quarter GDP growth numbers - 4.5 per cent, a six-year low - the government went into damage control. Atanu Chakraborty, Secretary, Department of Economic Affairs, and K. Subramanian, Chief Economic Advisor, addressed a hurriedly called media briefing.
The government's usual comforting words were that the fundamentals of the economy are still strong, growth has bottomed out and that the growth rate from the next quarter would improve. A day before the second quarter numbers were announced, Nirmala Sitharaman told the Rajya Sabha that "if you are looking at the economy with a discerning view, you see that the growth may have come down but it is not a recession yet or it won't be a recession ever."
While technical differences between a slowdown and a recession are debatable, the fact that the growth of nominal GDP (measure of goods and services produced at current prices) has fallen sharply to 6.1 per cent in the second quarter, from the Budget target of 12 per cent, should worry the government and people at large.
Even on the real GDP front, if government consumption - which showed a 15 per cent jump in the second quarter and more or less supported overall growth - is taken out of the equation, the situation looks even worse. "For some time there was support from some sectors that are cycle independent like agriculture and government spending. The ex-agriculture and ex-government spending numbers indicate a core trend in the economy which is worse. It is not even 4.5 per cent," says Siddhartha Sanyal, Chief Economist and Head of Research, Bandhan Bank.
Yet there are no quick fixes in sight as most analysts believe that a revival from here would be a long winding road and may take some doing to reach even 7 per cent growth rate. Some even expect the third quarter to be worse than the previous two. Various institutions, rating agencies and brokerage firms have already revised their full-year GDP growth rate target from 6-6.5 per cent to 5-5.5 per cent. The Reserve Bank of India (RBI) lowered its full-year GDP growth estimate from 6.1 per cent to 5 per cent. Some have even predicted the 2019/20 growth rate to be below 5 per cent with brokerage house Motilal Oswal forecasting a 4.5 per cent growth in 2019/20.
What Led To This
From being the fastest growing major economy a quarter ago, India has now been relegated to much humbler levels due to various reasons, the primary one being a sharp drop in private consumption and drying up of investments.
Slowdown in private consumption, which accounts for 55-56 per cent of the economy, has been a cause of concern. In the last two quarters, private consumption grew at just 5 per cent and below, compared to 8.1 per cent in the previous four quarters. While data suggests that fall in demand is a more recent phenomenon, some experts believe the trend started with demonetisation in 2016.
"There has been a fall in different components of aggregate demand on trend basis in the post-demonetisation years. The highest weight in GDP is that of private final consumption expenditure (PFCE), which has been falling steadily," says D.K. Srivastava, Chief Policy Advisor, EY India. A recent NSO report on Household Consumer Expenditure said consumption slowdown is worse than being captured by the GDP data. As per NSO's Household Consumer Expenditure survey conducted between July 2017 and June 2018, the average monthly spending by an individual fell to Rs 1,446 in 2017/18 from Rs 1,501 in 2011/12, down 3.7 per cent. This is the first time in 40 years that household consumption has shown a decline.
A part of the problem is stagnant rural income amid a largely low inflation shown in agri and farm produce. Besides, slower uptick in construction work, mostly in the real estate sector, which is one of the biggest employers of non-farm rural labour, also affected the overall rural income and hence consumption.
The slowdown in construction sector is captured by growth in investments or gross fixed capital formation. Investment increase in the second quarter has dropped to 1 per cent, the lowest since 2014. Investments both by the government and the private sector account for 30-35 per cent of the GDP, and growth in it has been continuously slowing after touching a high of over 13 per cent (mostly driven by government investment) in the first quarter of 2018/19.
Subhash Chandra Garg, former Secretary of Department of Economic Affairs, told BT: "Bulk of the investment is done by the private sector. While government investments act as catalysts, the revival in the economy can take place only when private investments pick up."
Construction activities have been registering muted growth since the beginning of the year. In the second quarter, construction activities showed 3.3 per cent growth compared to 8.5 per cent in the corresponding period previous year and 5.7 per cent in the first quarter.
"In housing sector, especially residential housing, no investment is taking place. People are struggling with even those projects that have started. Those units are not getting sold or completed. Investments made in those units are far more than their value," says Garg, who believes that over-capacity in the sector has led to lower capital appreciation and lower rental yields.
Exports also remain a major area of concern, partly due to trade disputes between the US and China and realignment of trading agreements. India has for long seen its export growth swinging from negative to low single-digits. Though 2017/18 and 2018/19 showed some revival in exports with 10 per cent and 8.5 per cent increase, respectively, it is still far below the 20 per cent that commerce minister Piyush Goyal had recently said was necessary to make India a $5 trillion economy by 2024/25.
Of course, some people are of the opinion that the slowdown can partly be attributed to the clean-up measures that the government has undertaken. As Nilesh Shah, Managing Director of Kotak Mutual Fund and a part-time member of the Prime Minister's Economic Advisory Council, explains: "Clean-up of real estate, fiscal prudence, lower inflation, NPA (non-performing asset) clean-up, better tax compliance, etc, have resulted in slower growth in the short term. This is detoxification of the economy."
The economy is in a vicious cycle, and breaking free of it will be a slow and arduous process. Low demand leads to lower capacity utilisation, which in turn means slower rise in investment. And unless investment picks up and new jobs are created, income levels would remain stagnant, holding back consumption.
"The available capacity is already high in areas like cement, steel, manufactured goods, etc; much more than what the demand is," says Garg.
Fall in demand is driving down capacity utilisation as was shown by the recently released Order Books, Inventories and Capacity Utilisation Survey (OBICUS) by the Reserve Bank of India. The survey showed that capacity utilisation declined to 73.6 per cent in the first quarter of 2019/20 from 76.1 per cent in the fourth quarter of 2018/19. This explains the 1 per cent growth in investments in the second quarter as also the drastic fall in credit demand, which declined 88 per cent from Rs 7,36,087 crore in April to Rs 90,995 crore in mid-September 2019.
"No growth can happen without money. This acute credit crunch has adversely impacted growth. Our real interest rate burden on banking system corporate lending is about 5.5 per cent. Entrepreneurs are finding it difficult to bear that burden," says Shah.
While some experts are hoping that a lower base effect will lead to an improvement in the second half, some high-frequency economy data says otherwise. "With the just-released index of eight core industries falling 5.8 per cent year-on-year in October, bottoming-out of growth could be further down the road. Recovery is unlikely to be V-shaped as consumer demand, credit supply and risk appetite remain lacklustre," says Sreejith Balasubramanian, Economist-Fund Management, IDFC AMC.
Yes, the government has taken some steps to address the issue, such as cutting corporate tax rates (from 30 per cent to 22 per cent), creating special funds to kick-starting stuck real estate projects, and more, but none of them seem to be showing quick results. Sanyal of Bandhan Bank says most of these steps address the supply side problems and not the demand side issues. While he believes growth has more or less reach a trough and further deceleration is not expected, he says any turnaround is likely to be a slow and long process rather than a sharp, quick uptake.
Rabbit Out of the Hat
Recovery will be slow, as most experts believe, but can the government pull a rabbit or two out of its hat to provide momentum to the revival process rather than letting it lumber along?
According to Garg, one of the sectors that needs a quick fix is residential housing. "Most things are related to that sector. If we can revive the demand there - we are still in a country where housing satisfaction is low - a lot of employment generation would take place, incomes would go up and demand would pick up."
To address the problem in real estate, the government has announced the creation of a special fund of Rs 25,000 crore for completion of stalled projects in affordable housing. As per industry estimates, in the stalled category, there are about 1,509 housing projects comprising about 4.58 lakh housing units.
The government can also speed up faster resolution of insolvency cases. The average time of resolution for Insolvency and Bankruptcy Code cases remains 330-360 days. According to Shah of Kotak Mutual Fund, the government needs to do what the US and the EU did after the 2008 financial crisis. His prescription includes providing ample liquidity, cutting nominal interest rates to zero and real interest rates to negative and increasing fiscal spending to support growth.
Shah also stresses that transmission of credit should be in line with the budgeted GDP growth. "There is no growth possible without credit. Don't starve the system like in the first half of FY19 with 88 per cent drop in fund flow to the commercial sector," he says.
According to Srivastava of EY, the main vehicle, however, would be investment from both private and public sectors. "All the three sources of public sector investment - central government, state governments and the public sector enterprises - will have to jointly uplift their investment rates. A very ambitious infrastructure investment plan was announced in the July 2019 budget speech of the finance minister," he says.
While many believe an income tax cut in line of corporate tax rate cut can also boost consumption, considering the little fiscal space available, the question is whether the finance minister would even bite the bullet.