Is the economic slowdown a structural one or a cyclical one? This question has come up repeatedly, and there are not many who would like to believe that this slowdown is structural.
In order to understand India’s recent slowdown, let us start with global growth trends pre- and post-global economic crisis (GEC). Following a decade of high growth before GEC and a swift rebound after it, many EMEs are seeing stubbornly slower growth since 2011. India is no exception, despite favorable terms of trade as oil prices fell. On the domestic front, the withdrawal of the fiscal stimulus put in place right after the Lehman collapse is relevant. But the problems since the stimulus withdrawal have demonstrated structural problems that need elaboration.
The real drivers of GDP are private consumption, private investment, exports, and government expenditure. Let us start with private consumption—most in the news recently. The surest indicator that this crisis is mainly structural is that real wages, both rural and urban, have been flat between 2012 and 2018 (the exact opposite of what was happening between FY05 andFY12)—primarily because non-agricultural job growth has been very low, compared to the earlier period (when 7.5 mn new non-agri jobs were being created annually and open unemployment was 2.2%). Non-agri job growth since 2012 has been 2.9 mn pa, and open unemployment rose to an unprecedented 6.1%, with youth rates double or triple that. Consequently, real wages for regular urban workers that had risen from `183 per day in FY05 to `226 in FY12 (a 24% increase), have actually fallen to `205 (or a 8.9% decline) between 2012 and 2018. Rural regular wages, which had risen by 13%, fell slightly. Urban casual wages in real terms had risen by 31% earlier, rose only 7.1% between 2012 and 2018. Rural casual wages had risen 44.5% before 2012 but barely rose 6% over 2012-18.
The current crisis is one of incomes, driven by poor non-agri jobs growth. While manufacturing jobs rose by 11% between FY05 and FY12, they fell by 5.7% between 2012 and 2018. Construction jobs that account for most of the jobs that rural migrants take up rose by 96.5% compared to 8% recently; services 18.6% vs 13.4%.
With wages and incomes down, people can maintain consumption only by cutting savings. So household savings fell from 23.6% (FY12) to 17% of GDP (2011-12 series), i.e. to levels prevailing in the early 1990s. Of this, financial savings as a share of GDP are 7.2%, or at levels prevailing between 1990-1997. Naturally, a second driver of GDP growth, gross fixed capital formation is down to levels before FY05, when the dream run began; at 28%, they are nearly 6 percentage below that in FY12. As income growth is lower, consumption is compressed or only maintained at the expense of savings. Despite private corporate savings having risen from 9.5% in FY12 to 11.6% of GDP, there is no “animal spirit” for investment growing faster.
Merchandise exports were lower over FY18 than in FY14 in $ terms; as a share of GDP they fell from 17.2% in FY14 to 11.6% in FY18. Can the fourth driver of aggregate demand, government expenditure, be expanded? There is a “silent fiscal crisis”, and the non-discretionary revenue expenditure and off-budget expenditures leave little elbow room for capital expenditure, certainly by the Centre (budgeted FY20 capital expenditure to GDP is 1.3 as against 1.4% in FY19). The fiscal consolidation path cannot be abandoned; as it is, the public sector’s draft on financial savings is nearly crowding out private investment (if there was appetite for it, to start with).
India’s fiscal stance in the run upto GEC was pro-cyclical, with large increases in appropriate compensatory (e.g. MGNREGA, MSP) and also infrastructure expenditure, but tragically also one-off very large farmer loan waiver in 2008 (announced before the GEC broke). But growth pre-GEC had been robust, that fiscal space still existed to pump-prime the economy from late-2008 onwards. India’s fiscal stimulus was large, its quality poor as it focused on revenue expenditure (the exact opposite of China); in 2013-14, the gross fiscal deficit was still 4.5% of GDP. In 2014, the government went into fiscal consolidation overdrive to bring the deficit down to 3.4% in FY19. Hence, there is still no fiscal space to use public investment to stimulate the economy now. This is one element in the current cyclical downturn.
The second cyclical element is the outcome of monetary policy. In the aftermath of the GEC, a former RBI Deputy Governor has argued rightly that “Indian monetary policy could have tilted unduly towards the “easy” side and could have prolonged the expansionary monetary policy cycle for a longer period than what would have warranted”. Together with the fiscal stimulus, it brought inflation in its wake, and RBI’s inflation-targeting stance.
However, since the November 2014 “taper tantrum”, the real repo rate rose to 4% from negative territory, and has remained at 2-3% in real terms since. This is an important reason why inflation targeting is recognised to have had a negative impact on growth rates.
However, over-borrowing when the real interest was in negative territory post-2008 underlies the NPA-crisis. NPA-overhang is the foundational reason for low borrowing continuing; the NBFC crisis exacerbated it, especially for MSMEs.
Some short run actions are necessary, but will be palliative. On monetary policy, action is needed to reduce the repo rate. A real rate of borrowing of 2.5% cannot be conducive to borrowing when animal spirits are weak, and capacity utilisation running at 70-75% depending upon industry. There is some recent increase in credit offtake, and hence sharp rate reductions are necessary. Second, banks will have to transmit rate reductions, requiring an institutional mechanism (as the RBI Governor has indicated). Third, the rupee has to be allowed to depreciate slowly, since the rising real effective exchange rate has hurt exports. On fiscal policy, given the limited fiscal space, the only possibilities of raising revenues are of the non-tax type: monetise government and PSU land as rapidly as possible. Railways hold 10 mn hectares surplus that can be either sold or leased out, generating revenues over a long time. Second, the goal of divesting government equity in public enterprises and in PSBs will also generate resources for increasing public infrastructure investment—which should crowd in private investment. It could be partly used to recapitalise PSBs.
But monetary and fiscal policy measures alone cannot do the trick. A sustained growth path requires such measures fall within a medium term strategy, including an industrial policy and other structural reforms, especially financial sector reform. The strategy would not succeed unless agricultural growth is 4% plus pa. That requires a tilt away from the price- and subsidy-based current regime to a strategy-based one on public investment in agriculture.
India is nowhere close to a middle-income trap, that some economists have argued it is in. We have the potential to grow at 7-8% pa in real terms, and thus potentially become a $5 trn economy in five years.