India traditionally never had a demand problem. On the contrary, its economy was always supply-constrained.
Proof of no demand paucity is that between 2000-01 and 2015-16, domestic consumption of both finished steel and cement roughly trebled, from 26.3 million tonnes (mt) and 92 mt, to 81.5 mt and 269 mt, respectively. During the same period, annual sales of passenger vehicles quadrupled (from 6.9 lakh to 27.9 lakh), while growing 4.5 times in the case of two-wheelers (from 36.3 lakh to 164.6 lakh) and five times for commercial vehicles (from 1.4 lakh to 6.9 lakh). Also, the total air passengers flown jumped nearly 10 times (from 14 million to 135 million) and the number of telephone connections 30-fold (from 36.3 million to 1059.3 million).
Supply not keeping up with demand — recall those long waiting periods for telephones, LPG connections and Bajaj Chetak scooters — was also manifested in inflation. Annual retail food inflation during the Nineties, and even the 10 years from 2006-07 to 2015-16, averaged 9.8 per cent. Not surprisingly, “supply management” measures — be it stocking limits under the Essential Commodities Act, export bans, zero-duty imports or selective credit control to restrict bank finance against cereals, pulses, sugar, oilseeds and raw cotton — were par for the course.
All this has changed in the last three years or less. The certainty that producers once enjoyed — of finding buyers for their wares without doing much beyond minor price adjustments to bring supply and demand into equilibrium — has ceased to exist.
This hasn’t been an overnight phenomenon. It started with agriculture from around mid-2014, when global commodity prices crashed, leading to a collapse in export demand for Indian farm produce and simultaneously increasing vulnerability to imports. But the real deluge has happened in the last three years, especially after demonetisation. Consumer food inflation has, for 34 months running, from September 2016 to June 2019, ruled below general retail inflation and averaged a mere 1.3 per cent year-on-year.
While such a prolonged near-deflationary phase in farm prices is unprecedented, the other sector to have experienced a similar extended slump is real estate. According to the property consultancy firm Knight Frank, between 2013 and 2017, the number of new residential launches in India’s top eight cities plunged from 4,20,105 to 1,03,570 units, with sales, too, dipping from 3,29,238 to 2,28,072 units. 2018 saw a mild recovery, but it marked the fourth year of growth in residential house prices trailing overall consumer inflation, with the gap progressively widening since mid-2016. As on June 2019, the unsold housing inventory of 4,50,263 units in these cities was still equivalent to 9.3 quarters of sale. Like agriculture, real estate transactions are significantly cash-based. Small wonder, this industry’s woes have also intensified post demonetisation.
Explained: Two ways to look at GDP
But demonetisation and goods and services tax (GST) were events of late-2016 and 2017. Their effects shouldn’t plausibly have lasted beyond, say, March 2018, when the total currency in circulation had reverted to pre-demonetisation levels. India Inc had, indeed, welcomed demonetisation and GST, claiming that the temporary economic dislocations caused notwithstanding, these would help create a “level-playing field” vis-à-vis unorganised sector players who were avoiding taxes by doing business largely in cash.
What is interesting, though, is that the demand slowdown has spread to more industries in the last one year. Thus, sales of passenger vehicles have fallen year-on-year in every month between July 2018 and July 2019, barring October. The same goes for two-wheelers since December 2018. Hindustan Unilever, a bellweather for India’s fast-moving consumer goods sector, has posted a drop in annual sales volume growth from 12 per cent in April-June 2018 to 7 per cent in January-March 2019 and 5 per cent in April-June 2019.
The reasons for such all-round demand deceleration, when the worst of demonetisation and GST are behind us, are hard to fathom. The most common explanation ascribes it to the liquidity squeeze experienced by non-banking financial companies (NBFCs), following the serial defaults on debt obligations by Infrastructure Leasing & Financial Services Ltd last September. Now, it’s true that NBFCs were accounting for over a third of the incremental credit in the system, with their retail loans (mainly for vehicle, consumer durables and home purchases) alone rising by 46.2 per cent during 2017-18 on top of 21.6 per cent the previous year. To the extent that their funds via bank borrowings and issuing of non-convertible debentures or commercial paper have dried up, it has had an obvious ripple effect on the economy.
The argument, however, misses the point. NBFC credit expansion from 2014-15 was primarily fuelled by non-performing assets-laden public sector banks cutting back on their lending. The big credit explosion, moreover, took place only after and because of demonetisation, which resulted in a flood of liquidity with banks and mutual funds. This excess cash they then lent to NBFCs, either directly or through market-based instruments that allowed Indiabulls and lesser firms to get money almost as cheaply as HDFC. The party couldn’t have gone on. The NBFC credit freeze has, no doubt, affected sectors such as real estate, construction and automobiles. But how does one explain a third consecutive quarter of slowdown for even FMCG, as per the market research firm, Nielsen? And real estate’s troubles, we know, preceded the current NBFC crisis.
The diagnosis is clear: There is a fundamental problem of demand today — a devil India has never encountered before. At the core of it is incomes that aren’t rising enough. Not only have household savings come down — from 22.5 per cent to 17.2 per cent of GDP between 2012-12 and 2017-18, estimates Kotak Institutional Equities — but consumption is also feeling the pinch now. When jobs and incomes are under strain, how much can loan-pushing by NBFCs help? A two-wheeler loan has to ultimately be paid from one’s salary or wages.
The question well worth asking is how much of this income and demand stress is actually an outcome of demonetisation and GST? The informal sector, to quote T N Ninan (Seminar, January 2018), was some kind of an “employment sink” and “shock absorber” for the Indian economy. It also provided the underlying demand support for goods and services that were bought, stocked and distributed through vast decentralised networks.
The country’s formal economy may well be growing by 7-8 per cent, which the official GDP data is, perhaps, rightly capturing (though recent tax revenue and FMCG sales data makes even that seem doubtful). But if the informal un-measurable part has been contracting by 20-25 per cent a year, the effects on demand need no elaboration.
This article first appeared in the August 13 print edition under the title ‘The economy devil we don’t know’. Write to the author at email@example.com.