There is a sense of déjà vu with a difference, with the government going in for a series of announcements to reinvigorate the economy over the last couple of weeks. The first set of announcements came against the backdrop of mis-governance of the earlier regime. This time around, it is an acknowledgment that something is amiss in the economy with GDP growth for the first quarter of 2019-20 slipping to a six-year low of 5 per cent. While economists are debating whether the current slowdown is cyclical or structural, the fact is that jobs are not being created. Consumption is not picking up and companies are not investing like they used to. This has been the trend since demonetisation in 2016.
Growth, across sectors, barring electricity and the government, has been less than 8 per cent, and less than last year. Manufacturing, in particular, has grown by just 0.6 per cent in the first quarter, and while the high base effect of 12.1 per cent last year provides some comfort, the fact is that there is evidence of a washout in the auto segment with large job losses reported and with India Inc’s sales at around 4-5 per cent in the first quarter. In 2017, low growth was attributed to GST, which led to destocking and hence, lower production. This time, it is structural in nature, with the demand side dominating.
The trade and transport as well as finance and real estate sectors have also witnessed lower growth in the first quarter at 7.1 per cent and 5.9 per cent respectively. In the case of the former, lower economic activity has resulted in slower growth, while the latter still hides the major restructuring that is required. While public sector banks appear to be out of the NPA conundrum, the NBFCs, which have been a major financier of small and medium enterprises, infrastructure and housing sectors, have witnessed a setback. This has been a work in progress for almost a year now with banks not too willing to lend.
Growth in construction has also slowed down from 9.6 per cent in the first quarter last year to 5.7 per cent this year with limited activity seen only in segments such as roads, where the central government is involved. The private sector is still cautious in investing, as evident in the slight dip in the gross fixed capital formation ratio from 30 per cent of GDP in Q1 2018-19 to 29.7 per cent in Q1 2019-20.
The reason for the slowdown is more on the demand side. Households are not spending as employment generation has been limited and incomes have not been rising. The rural economy has been buffeted in the last three years by demonetisation and lower price realisation due to good harvests. It remains to be seen whether prices will firm up at the time of the kharif harvest. The auto and consumer durable segments have been affected the most on this score as the propensity to spend tends to be higher in rural areas, especially during the harvest season which coincides with the festival season. The sectors that have been doing relatively better are cement and steel, where expenditure is government linked, and segments such as housing, e-commerce and retail. However, the real estate segment has been under pressure with the NBFC route of financing being severed.
In this situation, there has been little incentive for industry to invest as reflected in the dip in fixed capital formation. Investment has been scattered and concentrated more in sectors like power, natural resources and metals — a part of which is coming from public sector enterprises.
The solution so far has been for the government to nudge the RBI to lower interest rates. But the impact has been limited as companies don’t borrow just because rates come down. There needs to be a reason for fresh investment in terms of prospects, and more importantly, there has to be demand. The housing segment has benefited to an extent as home buyers are better off. However, even a 50 bps reduction in home loan costs cannot on its own prop up demand as the repayment capacity of the borrower has to be there, which is dependent on growth in incomes.
It is only appropriate that the government, in the last fortnight or so, has come up with a series of policy announcements and there are indications of another round of reforms in the coming weeks, probably pertaining to the real estate sector. From more general announcements involving the reversal of some financially onerous measures announced during the budget and an attempt to revive the auto sector, the policies have focused on foreign direct investment and the banking sector.
How is one to read all these steps? The first package was more in terms of fostering operational convenience — reversal of the surcharge on FPIs and revisiting the clause relating to angel investors. SME payments are to be streamlined with a one-time settlement plan in place and the government is to ensure that it makes its payments on time for projects (over Rs 40,000 crore is stuck in the pipeline). Banks have been given Rs 70,000 crore through recapitalisation (this was already in the budget through recap bonds which was anyway fiscal neutral), and structures have been created for the corporate bond market. While the auto sector is to get some relief on depreciation on vehicles and the government has clarified on the validity of registration on Bharat IV vehicles, the government will now be buying new vehicles, which was barred earlier. But, the question is whether the government has more money to spend given its tight budget. The stocks of auto companies have not been enthused.
The FDI rules now give single brand more breathing space in terms of local procurement and setting up of physical structures. Also, 100 per cent FDI through the automatic route in coal mining and related activities has been permitted as has 26 per cent FDI under the government route for uploading/ streaming of news and current affairs in digital media. However, these rules take time to work out and one does not expect to see a flurry of capital flows.
Lastly, the big bank-merger plan announced on August 30 is progressive. But, it may not really add much on the credit side as the amount of capital to be provided remains unchanged and only the bank names would change. While governance standards will change, there will still be a reluctance to lend to risky projects. Therefore, while there will be fewer public sector banks, the mindset will not change. Besides, in the present environment, liquidity is less of an issue compared to the willingness to lend, given the credit risk profile of India Inc.
What is definitely missing from the policies announced so far is a direct stimulus in terms of financial outlays from the Centre. This is critical, as the problem is deep on the demand side. Making “doing business” easier is a positive, and creating mega PSBs a progressive step. But this cannot change the 5 per cent growth number immediately. Money has to be spent and a fiscal compromise is required. Or else, we will continue to walk the path of gradual upward movement.
This article first appeared in the print edition on September 3, 2019 under the title ‘Centre must loosen purse strings’. The writer is chief economist, CARE Ratings. Views are personal