The Consumption Problem Of Economic Slowdown
The Consumption Problem of Economic Slowdown
India’s economic growth (gross domestic product) was at 4.5 per cent in the second quarter of the current financial year. Gross Value Added (GVA), which is actually more representative of economic activity, grew at 4.3 per cent. The second quarter growth is the weakest since the fourth quarter of FY13.
Reasons for this Slowdown -
There are distinct features of the current slowdown which make it different from the ones in the past. First, multiple growth engines — consumption, investment, exports, credit — have all slowed down synchronously; earlier, one of these engines would offset the weakness in the other. As in the first quarter, the proximate source of the slowdown was the manufacturing sector. But, underlying this is a sharp deceleration of investment spending. The growth drivers were also quite concentrated, with a prominent source being government spending.
There was a modest revival of household consumer spending, but this might also be an outcome of high government spending.
Second, the previous slowdowns were more the result of supply shocks, while this one seems to be led predominantly by a weakness in demand. While the focus has been on the real growth slowdown, even more striking is the slowdown in the nominal GDP growth rates. Reflecting the changing dynamics of volume growth and inflation over the past three years, nominal growth halved to 6.1 per cent in Q2FY20 (over the same quarter a year back), compared to a drop of 2.5 per cent in real growth. This is a matter of concern since nominal growth shapes the behaviour of economic agents, consumers, savers and investors. Equally, this has implications for the policy response since multiple economic variables depend on nominal growth — for example, the most immediate effect is in the slowdown of the Centre’s tax revenues.
The services sector has held up better than manufacturing. While the industry growth dropped from 10 per cent in the June 2018 quarter to -0.5 per cent in Q2, the services sector only modestly decelerated from 7.5 per cent to 6.4 per cent. The concern regarding this persisting deceleration is of the manufacturing slowdown spilling over to the services sector, both in construction and particularly in transport, where the weakness is evident both in data and anecdotal evidence. From the demand side of national accounts, private consumption growth is likely to be as low (or lower) as the first quarter based on public data like auto sales and results of service companies.
Third, the earlier slowdowns seemed to be led by the real sector. This time, the problems seem to have originated in the financial sector and then spilled over to the real sector through mechanisms similar to Ben Bernanke’s model of a financial accelerator. The credit squeeze has played a large role in amplifying the factors decelerating consumption and investment. The RBI data showed a striking drop in the flows of funds from multiple lending channels, from Rs 7.4 lakh crore in April-September 2018 to Rs 91,000 crore in the first six months of this year. Bank credit growth has dropped to 8.5 per cent in October. How does policy respond to this situation? A clear path for a revival in growth is not immediately obvious. The second quarter growth was most likely the bottom, yet the initial signs of a revival in the third quarter are modest.
Missed Opportunities -
Two successive finance ministers, Piyush Goyal in Interim Budget in February and Nirmala Sitharaman in Budget 2019, missed golden opportunities to revive the consumption cycle. If they had, instead of searching for the bottom of the still decelerating economy, the GDP would be on the turnaround path by now. It has cost the Indian economy two precious quarters, probably more.
Not only did they fail to acknowledge that consumption was the Pied Piper of slowdown, they even tried to put the cart before the horse by seeking private investment instead of focusing on reviving consumption.
That was not to be. That can never be. Horse pulls the cart, just as consumption pulls investment, not the other way round. It was a mirage to expect private investment when industry's average capacity utilisation was still in the low 70s. Entrepreneurs are not that foolish.
Besides the misdirected Budgets of the two finance ministers, some commentary has muddled the waters further by suggesting that large scale disinvestment, structural reforms and export incentives can help turn around the economy.
Far from it. Structural reforms take 4-5 years to deliver results. We can't possibly wait that long to revitalise the economy. And disinvestment is a one-time bump in government's earnings.
Of course, both of these are required in the long run, but what a decelerating economy needs the most to start delivering results in one-to-two quarters is consumption revival. That has to be the immediate priority of our government as well, though it seems it isn't. Thereafter, we need economic measures in the medium and long term to sustain the revival.
HOW DO WE GET CONSUMPTION GOING?
It's simple. Leave more disposable income in the hands of individuals and more investible surplus in the hands of corporates. How?
- Force banks to transmit repo rate cuts (only 1.1 per cent of the 2.6 per cent repo rate cut has been passed on) seamlessly to the consumer and industry
- Tinker with GST and other tax rates as far as possible (auto industry, for instance, is asking for 18 per cent GST instead of 28 per cent)
- Implement new Direct Tax Code and corporate tax at 25 per cent across the board
- Perhaps, an economic stimulus with a combination of the above coupled with an investment allowance (deductible against tax payable) to encourage fresh investment into new plant and machinery
- But above all, accelerate public investment into infrastructure creation and hope that the contagion spreads through sectors such as steel, cement, wires, tiles, etc. All of the world's major economic revivals have happened via public expenditure alone
- Such immediate measures will begin to show results within 2 quarters.
Besides those immediate measures, the Indian economy requires short-term measures that will deliver results in 1-2 years and long term structural reforms that will deliver results in 4-5 years and beyond.
In the short term, India needs to:
- Make GST simpler; bring liquor, fuel in GST ambit as well
- Make IBC simpler and time bound
- Relax FDI rules
- Get RERA implemented across the country to resurrect real estate
- Reform banking
- Introduce investment allowance for a few years.
In the long run, we need structural reforms to make the recovery as robust and well entrenched as possible.
- Government, the biggest litigator with over half the pending cases in courts, must exercise caution in appeals
- Labour reforms that compress 40-odd labour codes and reduce compliance time and costs
- Land reforms to make land available to industry on-tap
- Ease compliance burden/ease of doing business across the country; not just in Mumbai and Delhi
- An attempt to revive the economy via structural reforms alone is a 5-year agenda. India can't wait that long; waiting for GST, IBC and banking reforms to settle down to trigger economic revival is taking it into a 2-3 year horizon. The nation can't wait that long either
There are only three ways to revive a decelerating economy in 1-2 quarters. And they are: Consumption, Consumption and only CONSUMPTION. Everything else is a longer term horizon that is essential but can't deliver immediate results, as well as consumption can.