India’s fourth quarter GDP growth (calendar year 2019) printed another sub-5 per cent growth rate. It would have been lower had it not been for the large downward revisions to previous years’ GDP that statistically boosted the last quarter’s growth rate because of favourable base effects. Policymakers and the market heaved a sigh of relief that the relentless decline over the last three years at least seems to have stabilised around 4-5 per cent. But, because year-over growth rates are so strongly affected by what happened a year ago, most economies (including China) instead publish and conduct policy discussions based on sequential quarterly growth. Also, sequential growth rates provide a much better sense of the momentum and turning points in activity, which are critical to decide whether, how much, and when the economy needs policy support. If they had done so, both policymakers and the market would have found that the growth momentum rose, albeit modestly, from 3.8 per cent in the third quarter 2019 to 4.1 per cent. More importantly, non-farm and non-government GDP (the closest approximation to non-farm private sector GDP) bounced much more sharply from 1.6 per cent (and no this is not a misprint) to 4.4 per cent in the fourth quarter.
With the revised data, we now know that annual growth over the last four years has slowed from 8.3 per cent to 7 per cent to 6.1 per cent to 4-5 per cent. In sequential terms, the deceleration was far more dramatic, especially in non-farm private GDP, which after hitting a run rate of 13 per cent in the first quarter of 2016 fell to 1.6 per cent by the third quarter of 2019. What explains this four-year long slide in growth? The dominant narrative is that India’s woes are just an unfortunate and unintended consequence of demonetisation, the shift to a national GST, and the credit squeeze caused by the bad debt in banks and non-banks. With a bit more fiscal support, some monetary easing, and extended regulatory forbearance to help banks work out their bad debts, these headwinds will fade and India will likely be back to its winning ways.
While it is undeniable that these headwinds had been disruptive, they couldn’t be the drivers of the decline. India’s growth had been sliding since the second quarter of 2016; nearly 6 months before demonetisation and a year before the GST was introduced. Indeed, by the third quarter of 2016, non-farm private sector growth had already slid to 3.5 per cent. And although bad debt hit the headlines in 2016, the overleverage had already begun to tighten bank lending since 2014.
More inexplicable is the argument that falling corporate investment is the main culprit for the slowdown. It is true that corporate investment is no longer running at the heady 17 per cent of GDP of the pre global financial crisis (GFC) days, but at a much more somber 11-12 per cent. However, this outsized adjustment had already taken place by 2010 and since then, corporate investment has flatlined at current levels. Instead, what has fallen relentlessly in these past few years is private housing and SME investment: From 15 per cent of GDP to less than 10 per cent in the last seven years.
All these are signs that the answer lies elsewhere. And it is obvious once one eschews India’s exceptionalism and accepts that it is just another emerging market economy that grew on the coat tails of globalisation with the minimal reforms. Globalisation has largely determined India’s fate.
Contrary to a widely held misperception, India is and has been for a long time far more open to the global economy than believed. The limited liberalisation of 1991-92, coupled with the corporate restructuring in the late 1990s, spurred corporate investment to rise from 5-6 per cent of GDP in the early 2000s to 17 per cent of GDP by 2008. Almost all of this expansion in investment was geared to produce for exports, which grew at an astonishing pace of 18 per cent per year-over-year in this period as global trade expanded at breakneck speed with the entry of China into the WTO in 2001.
Exports as a share of GDP more than doubled from 12 per cent in the early 2000s to over 26 per cent by 2008. In contrast, private domestic consumption, which is considered to be India’s great strength, grew only at 6 per cent annually, less than the growth rate of the economy, such that its share in GDP fell from 63 per cent to 56 per cent. But since 2012, global trade has floundered and with that so has India’s economy. Indeed, the entire rise and fall of investment, including the quarter-to-quarter twists and turns in it, can be almost fully explained by changes in exports. The Indian economy has long been flying on one engine – exports — and that is now spluttering.
So will the nascent recovery strengthen and take the economy back to its high growth path? Unlikely on current policies. In the near term, as in now widely feared, the COVID-19 outbreak could turn into a pandemic, sharply reducing global demand and trade. With that, even expectations of a modest 2019-20 recovery to 5.25 per cent growth are under threat. Over the longer term, it is unlikely that global trade will return to its pre-GFC growth rates not only because supply chains have stopped expanding in the absence of any material technology breakthrough, but there is also a growing political backlash against globalisation in the developed market that has led to increased trade barriers. Consequently, India too, like other emerging market economies, needs to face up to the reality that it can no longer depend on global trade to be the only growth driver. Instead, it needs to search and find new sources of growth and that starts with recognising and accepting reality.
Policymakers need to stop thinking about India as a perennially supply-constrained economy focusing almost all policies and reforms to easing these constraints. Instead, it is time to let domestic demand play a greater role in India’s growth story. While this means that India Inc. needs to shift from producing what foreigners want to producing what residents can afford, it also means that policymakers have to reverse policies that have so far forced households to keep increasing savings (for retirement income, children’s education, healthcare, and housing) through a web of financial repression, regulatory distortions, and public spending choices. It means redesigning India’s infrastructure to look more inward and less outward, increasing public provisioning of healthcare and education, reforming insurance regulations to reduce out-of-pocket expenses, and eliminating financial repression to raise returns on retirement savings. Merely tinkering with macroeconomic policies will not be enough.
This article first appeared in the print edition on March 5, 2020 under the title ‘Way out lies within’. The writer is chief emerging markets economist J P Morgan Chase Bank. Views are personal.
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