As per the latest data on GDP growth, the economy grew by 5% in the 1st quarter of FY 2019-20. The dip in growth is alarming given the growth trend of last two decades and stands next only to what country witnessed in 2013.
The industry seems to
be in doldrums with “factory output
growth, measured by the Index of Industrial Production (IIP), slowed to 2 per
cent in June 2019, as compared to 7 per cent in June 2018”. (Slowdown
Blues: India's industrial output growth declines to 2% in June, 2019)
Deconstructing the slowdown
If we analyze the quarterly GDP growth & inflation rates over the last 2 years, we can see that economy is passing through Low-inflation-Low-growth phase. So current slowdown is basically a demand driven slowdown (Unlike a supply driven slowdown which leads to low growth high inflation situation)[*] (Kishore, 2019)
*To understand this phenomenon in more detail, read this
Low-inflation-low-growth: People don’t have the willingness or capacity to buy goods which leads to a demand depression fueling the vicious cycle of:
low-demand->low investment-> job loss -> low savings ->low demand
One of the reasons for this can be reduced capacity to buy, indicating the impact of jobless growth & low YoY wage growth rate. Second reason for this can be deliberate postponement of demand. In present scenario, both seem to be working in tandem.
While unemployment rate is possibly the highest in decades as indicated by NSSO data [*], YoY wage growth rate has also come down to single digit.
*A curious mind may want to research on how scientifically unemployment rate is calculated in India
The underlying reasons
The first culprit (Lack of investment)
On the macro level, if we take Gross Fixed capital formation (GFCF) as a proxy for investment; GFCF as a percentage of GDP has declined from 34.3% in 2011 to 28.8% in 2018. Similarly, gross domestic savings (GDS) as a percentage of GDP have declined from 32.7% in 2011 to 29.3% in 2018. But at the same time inflation has been very benign for last many years, it has come down from 10.03% in FY 2013 to 3.41% in FY 2019. (Matthew, 2019)
Takeaway
While the decline in GFCF is noteworthy, it’s not so steep or at such alarming levels to cause a slowdown. Further, the low inflation situation which is benign for consumers, reduces the incentive for producer to invest & produce; which may partly explain low GFCF.
The second culprit (Demonetization)
The bizarre policy of cancelling the tender of high denomination notes (Rs. 500/1000) allegedly in a bid to contain corruption.
As per estimates, it resulted in invalidating nearly 84% of total currency in circulation (out of total ~15.6 lakh crore) for settling transactions. The process of re-monetizing economy was long and painful.
As per estimates, it resulted in invalidating nearly 84% of total currency in circulation (out of total ~15.6 lakh crore) for settling transactions. The process of re-monetizing economy was long and painful.
Many sociologists cum economists give a folklorish reasoning as to how this resulted in behavioral change. The story goes like this, in the absence of cash people managed to survive for 3 months, they realized most of their expenditure was in fact extravagance. This realization resulted in sustained slowdown in expenditure, leading to low demand and current low demand driven slowdown is just one ripple of that Tsunami.
Takeaway
While no one really has data to prove or disprove this, the reasoning seems to be dumbed down to such a level (possibly to gain votes) that it stops making sense. So how much impact demonetization (which at worst was a short-term Pain) has on current situation; Cannot really say.
Third culprit (Goods & Service Tax)
Also termed as “Gabbar Singh Tax”, according to many noted intellectuals GST while good in concept was badly implemented. They blame the multi-tiered, complex, paper-work centric GST as the root-cause of many economic ills of today.
But like all intellectuals with ideological lenses, they fail to mention the complexity of what GST replaced. GST amalgamated nearly 16 indirect taxes which included intra-state taxes as well as inter-state taxes, levied and collected at different-different levels. (Mukhopadhyay, 2019)
The previous tax regime was a supremely complicated structure from the point of view of producers as well as marketeers (the whole supply chain basically).
So even if GST seems less than perfect right now, it’s a huge improvement on what existed before and could not possibly have resulted in choking the economy. So, what needs to be analyzed is comparative complexity of GST vis-à-vis Socialist Indirect Tax regime existing since time immemorial.
Takeaway
The only way GST has negatively impacted the commerce, is by pushing tax-compliance down the throat of celebrated job-creating MSME sector[*]. So, if anyone cries that GST screwed up MSMEs, he is basically asking to restore the PRACTICAL indirect tax-amnesty for MSMEs.
On the other hand, even for the MSME sector, compliance is a short-term pain with huge upside in the form of input tax credit in future. Unless these MSMEs are established Dwarfs (terminology explained in detail in Economic Survey 2018-19 which basically means MSMEs that refuse to grow), they also stand to gain from GST just like the formal sector.
* Economic Survey 2018-19 contains an in-depth analysis, busting the perception of MSMEs as major job-creators
Fourth culprit (Regulatory changes
& uncertainty)
Fourth culprit (Regulatory changes
& uncertainty)
This is true especially for automobile sector which has almost 50% weightage
in IIP. In July 2018, the S.C. ordered compulsory third-party insurance cover
for three years and five years for new cars and two-wheelers respectively. Along
with this imposition of safety regulations, rising fuel prices and increased vehicle
registration costs have resulted in increased total ownership costs (TCO) for
the automobiles.
Further, from the consumers end there is also a deliberate postponement of demand due to BS-VI implementation, diesel vehicle uncertainty, EV push and expectations of GST policy rate cut for the sector.
Further, from the consumers end there is also a deliberate postponement of demand due to BS-VI implementation, diesel vehicle uncertainty, EV push and expectations of GST policy rate cut for the sector.
Takeaway
Transition to BS-VI implementation was a long-established policy of the government.
However, there is a newfound vigour for environment and safety regulations
among both government & judiciary. While all these regulatory moves are
praiseworthy, these could & should have come at a more opportune time.
The culprit (IL&FS & NPAs)
When IL&FS defaulted on its interest payments on September 2018, it had an outstanding debt to the tune of ~1 lakh crore. It sent the whole NBFC sector in a tailspin (see their stock prices). These NBFCs had huge exposure to infrastructure & housing sector and due to its contagion effects, IL&FS seemed like the Lehman moment for Indian economy.
IL&FS crisis which then triggered the NBFC crisis, has caused an acute liquidity crunch in the economy.
For our present analysis we will use “No Liquidity = Economic Slowdown” as a maxim* (Explained: What does liquidity crisis mean?, 2019)
How it affected the MSMEs
For small scale firms and MSMEs, credit from NBFCs forms an integral part of working capital financing. As per Finance Industry Development Council (FIDC) NBFC lending to MSMEs has reduced substantially in 1st quarter of FY 2019.
Coupled with NPA issue, credit offtake becomes the most relevant issue haunting the current economy. As per NITI Aayog VC, Rajiv Kumar “There is no trust in the market among private players.”
How it affected Automobile sector
As per SIAM (Society of Indian Automobile manufacturers), 70% of two-wheeler sales, 30-35% of personal vehicle/cars sales and 60% of commercial vehicle sales used to be financed by NBFCs. So, when major NBFCs are looking down the barrel of NPAs and practicing extreme prudence in sanctioning credit, demand slowdown seems like a definite outcome.
Takeaway
The least discussed IL&FS crisis is actually the main reason for current economic slowdown. Now who is to blame for IL&FS and NPA crisis of the country, is the discussion which we will leave for another day (Further reading: here)
Conclusion
Even ordinary Americans cannot grasp what went wrong leading up to Global Financial Crisis (GFC) so it is a pipe-dream to hope that our Indian brethren will take the time and pain to read & understand how IL&FS caused economic slowdown.
When Finance Minister Nirmala Sitharaman in her press conference yesterday (06-09-2019) pointed out that liquidity crunch due to slashed NBFC lending, is the single largest reason for current slowdown, it all seemed like a technical jargon.
When Finance Minister Nirmala Sitharaman in her press conference yesterday (06-09-2019) pointed out that liquidity crunch due to slashed NBFC lending, is the single largest reason for current slowdown, it all seemed like a technical jargon.
So, if I were a political/ideological opponent; I would blame Modi, demonetization, GST, jobless growth, fascism & what not for current slowdown even when deep down I know, it was mostly IL&FS. Which brings us to the final question, are we content with watching the shadows or do we want to actually see the objects which cast those shadows?
Written By:
Shekhar Agarwal
(b18108@astra.xlri.ac.in)
CPPR, XLRI
References
(2019). Economic Survey of India. Ministry of
Finance.
Explained: What does liquidity crisis mean? (2019, August 23). Retrieved from Indiatoday:
https://www.indiatoday.in/business/story/india-liquidity-crisis-nbfc-ilfs-sectoral-slowdown-economic-growth-1590770-2019-08-23
Kishore, R. (2019, September 04). Why the 2019
economic slowdown is different from 2012-13 | Analysis. Retrieved from
Hindustan Times:
https://www.hindustantimes.com/india-news/why-the-2019-slowdown-is-different-from-2012-13/story-XuRgL94L1g82EaLGqasmAJ.html
Matthew, D. (2019, August 24). View: Is the current
slowdown cyclical or structural? . Retrieved from Economictimes:
https://economictimes.indiatimes.com/news/economy/policy/view-is-the-current-slowdown-cyclical-or-structural/articleshow/70814310.cms?from=mdr
Mukhopadhyay, S. (2019, March 26). Distorted
criticisms on GST. Retrieved from Business Standard:
https://www.business-standard.com/article/beyond-business/distorted-criticisms-on-gst-119032601448_1.html
Slowdown Blues: India's industrial output growth
declines to 2% in June. (2019, August
9). Retrieved from Businesstoday: https://www.businesstoday.in/current/slowdown-blues/slowdown-blues-india-index-industrial-production-declines-to-2-percent-in-june/story/371537.html
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