The Way Out Of What Is Now A Structural Slowdown

A 26-quarter low of 4.5 percent gross domestic product growth for the second quarter of 2019-20 was not surprising. Quarterly economic growth has been on a downward trajectory for the last six quarters, down 356 basis points from the 8.1 percent clocked in Q4FY18. The length of the present growth slowdown, at six quarters, is more than the previous phase of the four-quarter slowdown witnessed from Q2FY17 to Q1FY18, when growth had slowed from 9.4 percent to 6.0 percent.

Equally worrying has been the trend that the data prints are coming in lower than the estimates of most forecasters, and the median growth forecasts by various agencies. This prompts the question of whether the present slowdown has turned structural or is it still cyclical. Evidence suggests that the annual slowdown trend which started in FY18 has turned structural, and the phase of sluggish economic growth is likely to stay for some more time.

Some of the key reasons for this slowdown turning structural are:

• The fall in the savings rate to 30.5 percent in FY18 from 34.6 percent in FY12, within which the households savings rate is down to 17.2 percent in FY18 from 23.6 percent in FY12;
• Slower growth of nominal agricultural gross value added;
• Problems in non-banking finance companies,
• Higher delinquent assets for the banking sector, especially public sector banks; and
• The slow progress of resolution under the Insolvency and Bankruptcy Code.

Monetary Policy Rendered Ineffective

One important factor that differentiates the present phase from earlier ones is that what is happening now originated from the demand side, unlike previous supply-side episodes.

During the initial phase of declining income growth, consumers continue their spending by depleting their savings, and with some leveraged consumption. This is on the assumption that the slower income growth is a temporary/cyclical phenomenon. However, as they realise that the slower income growth is here to stay, it starts reflecting in a consumption slowdown.

In the July-September 2019 quarter;

• Core gross value added (excluding agriculture, and public administration, defence and other services) grew by just 3.4 percent, slowest in the current series.
• Barring public administration, defence and other services, all other production sectors’ growth contracted, both year-on-year as well as sequentially. Mining sector growth expanded on a year-on-year basis but contracted sequentially.
• Services maintained some growth momentum in the second quarter at 6.8 percent, albeit at 10 basis points less than the first quarter.
• The slump in the manufacturing sector led to a 6.9 percent decline in imports, the first in 12 quarters.
• The government is doing the heavy-lifting to support growth. Government final consumption expenditure contributed 1.9 percent to Q2 growth, the highest in nine quarters.

Economy Running On Only One Engine... Government Spending

Whether one looks at GVA or GDP, economic activity in the July-September quarter was supported mainly by the government. Public administration and defence in GVA is largely government-expenditure and core-GVA is a proxy for private or corporate sector activities, which has slowed considerably. Even headline GDP growth was salvaged by government final consumption expenditure, which grew 15.6 percent, highest in the last six quarters.

While gross fixed capital formation grew at a 22-quarter low of just 1.0 percent, government capital expenditure (central government and 20 state governments) grew 37.8 percent.

At a time, when the aggregate capacity utilisation has been hovering between 70 percent and 75 percent and demand is weak, it is unlikely that private or corporate capex will expand. The government too is struggling to meet its fiscal deficit target and has very limited fiscal space to stimulate demand.

Base Effect Bump In H2?

The ongoing agrarian distress and dismal income growth so far, coupled with subdued income growth expectations in urban areas have weakened the consumption demand considerably. Even the festive season has failed to revive it and this is reflected in the current data of non-food credit, auto sales, and sales of select fast-moving consumer goods. The present macro-economic conditions do give hope for a statistical growth revival in the short-run. While growth in H2FY20 is likely to be better than the first half, it will be mainly due to base effect.

Low inflation is affecting the government and corporate sectors in a similar way.

The impact of this on government finances (both central and states) is in the form of low tax collections and slippage in the fiscal deficit. The GVA growth in national accounts mirrors the sum of EBIDTA and wage growth on corporate balance sheets. Slower nominal GDP growth implies slower profit and wage growth, leading to a collapse of demand.

One Way Out

The need of the hour is to spur demand in the economy. A majority of government interventions in the last few months have tried to address supply-side issues and will have a favourable impact on the economy only in the medium- to long-term. One particular sector which could help revive the economy is real estate. Households are the biggest contributors to GVA, savings, and investments. Households have more than three-fourth of their investments in ownership of dwellings. Real estate has linkages to a large number of production sectors such as steel, cement, electrical cables, wire, furniture, etc. A faster resolution of stuck real estate projects has the potential to increase savings and consumption and could help to kick-start the economy again.

Devendra Kumar Pant is the chief economist at India Ratings. Views are personal.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.