Indian economy at crossroads, need not panic

Dr S Ananth shares insights on the present state of our economy and its problems. The slow economic growth is taking over due to a combination of factors, that include both external and internal, says the author.

New Delhi: Recent headlines on economic news, especially about possible slowdown has gained public attention. In the context of the slowdown, various government and RBI statistics along with the RBI's annual report provide very insights into the state of our economy and its present problems.

We should be happy as the RBI annual report indicates some interesting but important structural changes that are underway in the economy. We should be worried because it indicates that if the government is not careful, the present slowdown could well turn out to be a more serious issue. There is no doubt that there is a growth slowdown in India and the growth slowdown is taking shape rapidly.

This is due to a combination of factors, both internal and external.

The fact that India has never been an export-oriented economy has insulated India till now compared to other exported oriented countries in Asia, Europe or South America. Germany, a predominantly export-oriented economy has witnessed manufacturing decline for the past year: car production and exports of Germany are down 17% in the past year.

But that internal consumption-driven economy has its limitations – which are now coming to the forefront. Unfortunately, they are coming up at a time when the world is also slowing down due to the worsening of trade relations between USA and China.

Structural or Cyclical Slowdown

This invariably leads to the question of whether this slowdown will become more long-term structural slowdown or if it is a passing cyclical and seasonal slowdown.

As of now, the data seems to indicate elements of both – structural and cyclical aggravated by seasonal factors including monsoons and floods.

However, the economic data is simply insufficient to come to a hasty conclusion about the economy other than saying that there is a sharper than normal cyclical and seasonal slowdown.

It is important to note that we will have further clarity only by the end of the forthcoming festival season. If the slowdown persists even at the end of January then it should ring bells all around.

In the meantime, there is a need not to confuse decline in automobile sales with something more drastic. One of the reasons for the slowdown in vehicle production is that the new BS VI emission norms are due for implementation in March 2020.

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Hence, we do not know if the manufacturers have stopped production to get rid of the existing inventory apart from the cyclical factors.

Importantly, on an annualised basis, bank credit is still growing, though at a weak pace.

The other important consumption indicators that offer scope for optimism is that of the consumption of petroleum statistics.

The consumption of Diesel (HSD) and Aviation Turbine Fuel (ATF) indicates that as of now the slowdown is seasonal.

ATF consumption in the country (on a metric tonne basis) hit a new high last financial year at about 83.25 lakh metric tonnes while HSD consumption was a record 8.3 crore metric tonnes.

Seasonally, these numbers decline with the onset of monsoon i.e., June-July to October – November every year. This year is no different as far as these two indicators are concerned and there is nothing to panic.

Identifying Problem

The above conclusions lead us to questions about where the problem lies and, why there exists an economic slowdown? The problems are very real and are getting worse day by day.

However, the problems did not start this year but what is surprising is that even the costliest general election did give the economy a boost –which normally happens. The problems started with demonetisation and the badly designed GST and its faulty implementation.

Post these two events (Demonetisation and GST), households and small business which are one of the most important segments of the economy are in deep trouble – a fact that is indicative of the decline in gross household savings from 19.2% of the Gross national disposal income (GNDI) in 2014-15 to a low of 16.9% in 2016-17. It has only recovered marginally to 17% in 2017-18.

Worryingly, financial liabilities of the household sector increased from a low of 2.7% in 2015-16 to 4.3% in 2017-18 of GNDI – a figure that is likely to have only increased.

This increase is seen from the sharp increase in personal loans: from Rs.10.36 lakh crores at the end of March 2014 to Rs. Rs.22.02 lakh crores at the end of June 2019.

Apart from this, households are spending large amounts on various items of conspicuous consumption either in the form of eating in hotels, travelling for holidays, clothes and other items. Invariably, this expenditure is probably more out of a social and psychological urge rather than necessity.

Thus, while debts and unnecessary expenditure has increased, income growth has not kept pace. This exceptional and more than doubling of debts means that households have now reached the limits of their ability to consume. At the same time, the liabilities of the businesses, especially service sector too have increased sharply, though not to the extent of the household sector. Interestingly, the debts of manufacturing sector increased only by about 15% since 2014: from Rs 25.22 lakh crores at the end of March 2014 to Rs 28.58 lakh crores. In contrast, the debts of the service sector increased from Rs 13.27 lakh crores to Rs 24.15 lakh crores from 2014 to 2019.

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It is important to note that the claim that the banks are not lending is only partly true. SBI chairman has recently pointed out that the banks have abundant liquidity despite the problem of NPAs but the banks are being cautious simply because they are worried about further increase in NPAs.

Therefore the problem in the Indian economy is that there is no demand; in other words, the problem is from the demand side and not from the supply side. There is no dearth of capacity and there is no dearth of credit availability for those borrowers with sufficient creditworthiness.

The problem is that those who have the ability to borrow are not keen on borrowing while those who are highly indebted and are facing economic difficulties want to borrow but nobody is willing to lend to them.

Our economic problems have a long history and have not come up in one day. The problem is more fundamental and it has to do with our economic model which believed that as in countries like the USA, India can build an internal consumption-driven economy without a sufficiently large export and manufacturing base.

The problems in the Indian economy have been aggravated by three important reasons over and above the rising levels of household debts.

These include:

(a) a sharp increase in government borrowings,

(b) sharp rise in taxes which are squeezing out the last drop of surplus from already highly indebted businesses and households and,

(c) NBFC crisis.

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One of the biggest problems that the Indian economy faces is that despite the extremely low-interest rates globally, India still has a relatively high-interest rate regime.

One of the main reasons for that is that the government and government organisations including government companies are borrowing huge amounts thereby meaning that the huge demand for credit also forces the interest rates to remain high and tends to deprive the private sector of necessary cheap credit (referred to as “crowding out”).

This is aggravated by the fact that India is a capital deficient country and the fact that in the past four years savings of households has been declining. The government borrowings have doubled in the past five years.

Apart from Central and state governments borrowing large amounts of money, the borrowing by public sector means that banks believe that lending to the government and its bodies may be less risk: borrowings by public sector undertakings (PSUs) increased from Rs.46,400 crores in 2013 to Rs.1.26 lakh crores in 2019.

In all, about one-third of the total credit disbursed by the banks goes directly to the banking sector and this increases when the borrowings of Central and State public sector and institutions like FCI and others are also considered.

Another problematic aspect is that the borrowings have increased sharply despite a big increase in tax receipts for the government.

Tax receipts have increased from Rs 23.87 lakh crores to Rs 39.68 lakh crores in 2018-19. The government expects this to increase to Rs 44.12 lakh crores by the end of March 2020.

This huge tax squeeze by the government is responsible for the inability of the households to spend, especially in the context of a global slowdown and increased debts.

Among the taxes, the sharp increase in petroleum taxes and the increase in taxes on services are largely responsible for the decline in consumption power of the households. It is in this context that the crisis in the Non-banking financial companies (NBFCs) has to be seen.

Over the past three years, an important component of economic growth was the growth in the service sector. This service sector growth along with household consumption was facilitated by the lending by the NBFCs.

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In the aftermath of the crisis in some of these large finance companies, lending to these sectors has completely dried up. This has only aggravated the crisis.

The economy has reached a critical point and unless the government is careful there is a risk that the present cyclical and seasonal slowdown will become a structural slowdown.

Unfortunately, for the government, we have postponed taking hard decisions for too long. The time has now come for the central, state governments, companies and households to swallow the bitter pill. There are no easy solutions.

The only question now is whether we swallow the bitter pill today or whether we face worse problems in the future if we continue to postpone the solutions today.

Acts like transferring RBI reserves are short-term solutions that are like a “Brahmastra” which the government should not have used because they can be used only once. Now, that it has been used the only option for the government is to use the money from RBI wisely and not waste it on unproductive subsidies.

As for households and companies, the best way to prepare for the future is to reduce expenditure, pay off debts and conserve cash – i.e., spend wisely and save more.

In the economy, there is never anything like missing opportunities. For a growing economy like India, there will always be opportunities, just that one has to have money to take advantage of opportunities.

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