Above: Automobile sales have dropped by almost 35 percent from the previous year/Photo: eresearchnmarkets.com
While recession has not yet hit the country, weakening consumer and business confidence and the centre’s inability to understand the economic system, have increased the likelihood
By Sanjiv Bhatia
A question I get asked often these days is this: Is India headed for a recession? The standard definition of recession is a drop in GDP for at least two consecutive quarters. In other words, negative GDP growth rates and a contraction in the economy, signified by a decline in real income, employment, industrial production and wholesale-retail sales, spread out over at least two quarters.
So, while India is not currently in a recession and the economy is still expanding, the rate at which it is growing is declining. Can India slip into a contraction or have a quarter or two of negative GDP growth? Economic slowdowns can feed on themselves through psychology, or what British economist John Maynard Keynes famously called “animal spirits”. In an economy, there are millions of interrelated activities, and once the dominoes start falling and business sentiment becomes negative and consumer confidence turns to fear, a recession can occur.
With recent data showing deep contraction in several vital sectors, India could be at the inflexion point down the slippery slope. Automobile sales have dropped by almost 35 percent from the previous year, real estate sales are down 18 percent and even inexpensive consumer goods such as clothing, biscuits, and so on, have seen a drop in sales.
The next round could see large labour layoffs, followed by bankruptcies along the supply chain, including automobile dealerships, parts manufacturers, construction companies and real estate developers. This will result in further decline in consumption as unemployed people tighten their belts and loans and EMIs go unpaid. The vicious cycle of fear, uncertainty and loss of confidence will cause consumers and businesses to retrench and reduce consumption and investment and banks to stop lending. Eventually, through the multiplier effect, there could be a recession.
The last time India had negative growth was in 1979, so it is rare for a developing economy with a large and growing population to suffer a contraction. Each year in India, more people join the workforce, there are more mouths to feed, and there is an improvement in technology and innovation, which increases productivity. So, in its natural state, India will likely have an increase in production and, therefore, a positive GDP. Even in the period before 1991, a socialist “licence-raj” Indian economy grew at around 3.5 percentage a year because of an increasing population. This was at par with the growth of less-populated, but developed, free-market economies like the US.
At the minimum, therefore, because of an increasing population and increases in productivity brought about by a young workforce with greater access to better education, the internet and mobile connectivity, India should grow naturally at a minimum of around 3.5 percent per year. But that won’t improve the welfare of its people nor make India an economic powerhouse. A 3.5 percent increase in GDP translates to only about a 1.8 percent increase in per capita income. India’s GDP needs to grow at around 10 percent annually (in real terms) to be able to provide meaningful jobs to the seven million people that enter the workforce every year and to improve living standards for its poor.
Unfortunately, double digit GDP growth has also eluded India. Only twice in the country’s history—1988-89 and 2010-11 has real GDP growth crossed 10 percent. The notion, therefore, that India would suddenly start producing double-digit growth to get to a $5-trillion economy is as unlikely as the economy having prolonged recessionary contractions.
Four engines drive a country’s economic growth: personal household consumption, business investment, government spending, and net exports (export less imports). The most significant of these in most countries is household consumption, which is the sum of the goods and services bought by the citizens of the country. In India, personal consumption contributes 57 percent of the country’s GDP. In comparison, in the US, spending by households contributes around 65 percent of GDP and in an export-driven economy like China, only 39 percent.
More than half of India’s growth comes from personal consumption, so when households cut down on spending, GDP drops. The latest data shows that growth in consumption by Indian households in the first quarter of FY 2019 dropped by half from 7.2 percent to 3.1 percent. Demand for consumer durables (cars, appliances) in urban areas has dropped significantly and there has been a sharp deceleration in demand for fast-moving consumer goods in rural areas. There are many reasons for this drop: increase in unemployment, lagged effects of demonetisation, negative effects of high GST rates, decline in wealth due to a slump in the stock market and a general drop in consumer confidence. This engine, while still chugging, is slowing down and could grind to a halt soon. If that happens, the likelihood of a recession increases.
The second driver of economic growth is business investment, i.e., investment made by companies in new plants, equipment and research and development. At its peak in 2011, capital investment by Indian businesses accounted for 41 percent of GDP. But that number has declined to 31 percent in 2019. Companies have drastically cut down on new capital investments and this could have serious ramifications for future growth. According to data from the Centre for Monitoring Indian Economy, new investment projects announced by Indian companies in the second quarter of 2019 were 81 percent lower than in the first quarter and 87 percent lower than the same period a year ago. And this decline in investment is broad-based across all sectors. Investments in the manufacturing sector are down 68 percent from last year and investments in the services sector by 98 percent compared to the same period last year. Essentially, this engine of economic growth is slowly grinding to a halt.
One of the reasons for this structural decline in business investment is the low level of business profits resulting from high levels of taxation on both input factors and output. India’s companies are the least profitable among major emerging and developed economies. The combined net profit of BSE 500 companies in 2018 was $63 billion, which is equivalent to 2.31 percent of the country’s GDP. This number is 6.1 percent in the US, 4.24 percent in Brazil and 3.63 percent in China. Profits of Indian companies are at a 15-year low and have declined 28 percent from FY2018. This has had a significant impact on new business investments.
These large declines in business investment also point to a deep decline in business confidence. Government policies have become increasingly inconsistent and extractive. Political expediency, and not good economics, is the driving force behind many government policies. And when the expected pushback happens, the policy is often retracted. Several policy initiatives announced in the budget were retracted within a few weeks. There have been over 400 changes in GST rates and structure since its inception two years ago. These constant policy vacillations are detrimental to business planning and reduce the business community’s confidence in the
government’s ability to deliver well-reasoned, helpful, smart and consistent policy changes.
Another contributor to weak business sentiment is the coercive nature of India’s tax system. The government has promised and spent far more than it can afford. Its projections of tax collection from GST were unrealistic and now it finds itself between the rock of a ballooning fiscal deficit and the hard place of welfare promises to appease voters. Tax collectors, acting much like their counterparts from the days of the Roman Empire, are given tax collection targets and have a free hand to shakedown wealth and job creators.
The business fraternity has pushed back hard, and many business leaders have gone public with their resentment over the strong hand of the state. The recent tax surcharge on the “rich” is an excellent example of extractive tax policies that have consequences far beyond any potential benefit.
The government recently put out conciliatory messages for the “wealth creators of the country”, but it appears, the horse has already left the barn and the business community’s trust in this government to liberalise the economy and improve economic freedom has been badly and irreversibly shaken.
The level of fear is high, and that is not conducive to risk-taking and business investment.
The third contributor to growth is government spending. In India, it accounts for about 10 percent of GDP with the bulk of it going towards current consumption—interest payments, salaries, pensions, subsidies and transfer payments—taking from Peter to pay Paul. So, the majority of government spending has very little structural impact on economic growth. Remember, what the government spends, it takes as taxes from the citizens (which correspondingly reduces their consumption) or from borrowed money (which reduces future consumption) or by printing new money (which causes inflation and reduces the value of existing wealth).
The part of government spending that affects long-term growth is investments that create future benefits like infrastructure (roads, rail, airports), health (sewage, waste management, pollution) and research spending (defence, space, genetics).
In India, however, only about 12 percent of government spending is in these investments and that amount has been going down steadily and is expected to fall to 9 percent by 2020.
The final engine that drives economic growth is net exports—exports minus imports. This engine has been the primary driver of economic growth in many Asian countries like China, Japan, South Korea, Taiwan. But in India’s case, because imports exceed exports, trade detracts from growth instead of adding to it. The country has a negative trade balance (exports minus imports) which reached a record high of minus $176 billion in 2018-19. India’s exports have been stagnant, and in the last five years, its share in GDP has dropped by 4 percent. The value of the country’s exports, as a percent of GDP, is the lowest since 2003. Much of the decline in exports can be blamed on government policies. The abolishing of a secondary market for cattle hurt the leather industry. A tax hike on the import of gold and diamonds hurt the gems and jewellery industry. And the government’s inability to promptly send GST refunds to exporters killed the working capital of many small and medium-sized exporters and put them out of business. The trade engine is dead as far as India’s economic growth is concerned.
All the four engines that drive a country’s economic growth are sputtering in India and could eventually stall. So, while the country is not currently in a recession, the probability of it going into one has increased dramatically. Things are likely to get worse because of weakening consumer and business confidence. There is growing concern about both the government’s inability to understand the structural weaknesses in the economic system, and its complete unwillingness to contemplate and debate appropriate policy reforms.
The immediate future for the country’s economy appears bleak.
—The writer is a financial economist and founder, contractwithindia.com
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