The economy has slowed. Now that there is a consensus on that, the debate has moved to how severe it is, how long it can last, and where the intervention needs to be. Like a snowball that grows bigger as it rolls on, economic momentum builds in a certain direction till a force (intervention) is applied. The later the response, the stronger the necessary intervention.
This amplification of the prevailing trend plays out on several fronts. Let us start with financial conditions. Once financing conditions tightened after the default by a large financial firm about a year back, the resultant economic weakness pushed more firms into default.
For a few quarters, private financial firms that had the potential to grow took advantage of the lack of competition and grew their loan-books profitably. But now, as the underlying issues stayed unresolved and growth has weakened further, afraid of new bad loans, even they are slowing down credit disbursement. This is now likely to cause the next round of weakness.
Similarly, supply chains sometimes act like bull-whips: The handle of the whip moves slowly, but the end of the whip can move at the speed of a few hundred kilometres an hour. Relatively small fluctuations in end demand can get amplified further up in the supply chain: A retailer sees a 2 per cent drop in demand, and decides to shed some inventory too; now the wholesaler supplying the retailer sees a 5 per cent drop in demand. By the time it reaches the manufacturer, the apparent demand could be down by 10 per cent. They then cut output and component suppliers, further upstream, send contract workers on leave.
What is happening in the auto supply chains currently is a good example: Car registrations last month were down 11 per cent, but sales by manufacturers were down more than 30 per cent. The resultant production slowdown leads to income losses in the economy, particularly if there are many temporary workers (recall that less than 20 per cent of Indian workers work with a salary slip), and that further weakens end-demand. For autos, the situation has likely been exacerbated by the technology transition scheduled for next year, which is a disincentive for the supply chain to hold much inventory, particularly when financial conditions are tight.
But this is visible even in soaps and shampoos. Lack of credit is also driving inventory liquidation in real estate, as “investors” (that is, people who bought apartments as investments), partly in need of cash, and partly in fear of further price declines, stampede out of the market. This slows down cash flows to developers and intensifies their distress.
The third front is fiscal. Government revenues weaken with economic activity. In particular, destocking in the economy hurts GST collection (a large part of the GST on a product is paid when it leaves the manufacturer). In the first three months the government’s expenditure grew at just 2 per cent, against the full year budgeted target of 21 per cent. Given the slippages on taxes, it is unlikely that the government will be able to increase its pace of expenditure.
This worsens the slowdown: Fixed annual fiscal deficit targets are inherently pro-cyclical in nature. In a slowing economy, they intensify the weakness, and in an accelerating economy, they provide even more fiscal room for the government to spend.
It is tempting to ignore this, or just hope that the economy self-corrects. As one can expect, in a complex economy like India, where hard data is limited, perceptions of the slowdown run at a different pace from ground reality. With millions of people viewing the economy through different prisms, sometimes the collective conscious chooses to ignore signs of weakness, and at other times the sense of panic overshoots reality.
Sales of smartphones, some consumer appliances, paints, and plastics, for example, were healthy in the last quarter. However, as discussed above, the weakness has worsened in recent months, and even these sectors may then start to follow the broader trend.
One should also not dismiss the group-think, as it too matters, affecting individual decisions on consumption and investment that add up to the economic activity measured as GDP. Dented confidence of consumers and companies, if not nipped in the bud, can by itself cause economic weakness. A significant pickup in monsoon activity (from a 19 per cent deficit a month back to a 1 per cent surplus now) should help sentiment incrementally, but the weakening global macroeconomic backdrop is a growing challenge.
So, then, what may be the interventions that can stop, if not reverse, this downward momentum? Significantly lower interest rates or a faster pace of base money injection by the RBI are likely to help, but they may no longer be sufficient to drive a recovery.
As discussed in these columns earlier (‘How to use the mandate’, May 31), the government needs to take a decisive approach on the financial architecture in India: It needs to take an axe to the system, as a scalpel will no longer suffice. For the economy to grow at 12 per cent, given the objective of increasing formalisation, total formal credit needs to grow at well over 15 per cent, and the current ecosystem does not appear capable of providing that.
Many, including this writer, have recommended large disinvestments to bridge the fiscal shortfall and maintain government spending growth, particularly on infrastructure; it would also serve the dual purpose of signaling the reform intent of the government to economic participants, in addition to, over time, improving productivity of those assets.
The likely dent to the political capital of the government may be offset by the resultant change in economic sentiment. It is important to remember that a three trillion dollar economy needs steady structural reforms to maintain its growth momentum.
The government’s first response shows a desire to intervene to rectify problems; more may be on the way and necessary. Governments, globally, respond with progressively greater force as they calibrate the intensity of the intervention, the dose of the medicine. Milton Friedman, a Nobel laureate in economics, once wrote: “Only a crisis — actual or perceived — produces real change. When that crisis occurs. the politically impossible becomes the politically inevitable.”
The bull-whip works both ways: When supply chains have already shed their inventory and demand suddenly picks up, the positive side of the cycle can be as exciting as the negative side is depressing. Other cyclical factors can then also turn supportive. But changing the momentum is the challenge, and one hopes that the right interventions come sooner rather than later.
This article first appeared in the print edition on August 30, 2019 under the title ‘Seize the slowdown’. The writer is the co-head of Asia Pacific Strategy and India Strategist for Credit Suisse.