Indian Economy: It's serious. Multiple structural downturns make this slowdown unlike others
Prime Minister Narendra Modi’s grand victory in the General Elections is not the only historic event of 2019. Equally historic is the unprecedented slowdown in the economy that leaves us with a sombre puzzle — what is easier: winning a mega election in India or reviving an ailing mega economy?
No points for guessing the answer. The 2019 election mandate gives you the hint.
However, when it comes to the state of the economy, going by the Reserve Bank of India (RBI)’s straight thumbs down (from 7.2% to 7%) to India's FY20 growth estimates and revenue administration’s cry for a cut in FY20 tax collection target, the path to economic recovery appears daunting, stretching well beyond expectations.
A bizarre breakdown
For an economic slowdown in India, this time, it is different. Unlike past downturns, driven by global upheavals, bad weather, inflation, currency volatility and high oil prices, India is now in the middle of a stubborn structural slowdown. In its recent bouts with decelerating growth, India could bounce back each time thanks to a resilient domestic economy — but it is for the first time since economic liberalisation in 1991 that the country is facing a downturn primarily led by private consumption.
In fact, private consumption by its gigantic population that contributes over 55%-60% to gross domestic product (GDP) was the force behind India's rapid bounce-back after global turmoil in the late years of the twentieth century (Asian Financial Crisis) and in early years (Lehman collapse and global banking meltdown) of the 21st century.
What makes this slowdown even more complex is that the Indian economy is facing the sharpest decline in its savings rate in 20 years.
Coupled with ever growing piles of bad loans in formal and shadow banking (non-banking finance companies), India is staring at its first experience with borrowing defaults — and contagion in the financial system.
When an ailing economy needs a massive dose of vitamins in the form of funds, the funding pipeline of governments (centre and states) has dried up, due to rising deficit and sinking revenues, while the financial system is going through an acute liquidity crunch due to rising borrowing costs and risk aversion among financiers.
A never-seen-before shrink
On the one hand, private capital expenditure has been sluggish for six years — on the other, the consumption engine that was pulling the economy seems to be losing steam.
The ongoing consumption breakdown is fairly broad-based and a structured one. Housing demand has been sluggish for the past several years. Auto sales volumes saw a slowdown from the second half of 2019 and general consumption (based on volumes of consumer staple companies) from the fourth quarter of 2019.
The ongoing consumption slump in the world's fastest growing economy is a result of a toxic mix of a decline in savings, credit, income and business confidence — all in tandem, of which there are no traces in the recent past. This has led to a synchronised collapse of demand in credit-driven sectors such as housing and auto (leveraged consumption) and income-driven buying of consumer staples.
Defaults and contagion
Thanks to excess liquidity in the system post demonetisation, NBFCs had been at the forefront of lending in the last three years. While banks were struggling with bad loans, NBFCs reportedly accounted for 75% of incremental auto loans in FY18. It is no coincidence, therefore, that the consumption story turned bad only after the NBFC crisis erupted and got prolonged. The consumption scale-up in the past three to four years was not driven by a rise in personal income (income growth was actually weak), but because of a significant expansion in lending by NBFCs.
NBFCs are not allowed to take deposits. They borrow money from banks or sell commercial papers to mutual funds to raise money.
In the last few years of high inflows of cash, banks and investors parked their money with mutual funds. The supply of cheap funds from banks and mutual funds helped NBFCs grow their loan portfolios at double the pace of banks.
As inherent economic weakness has started hitting the credit recovery, NBFCs have found themselves in the massive mismatch between assets and liabilities that has led to downgrades in their ratings and then, eventual defaults. According to a report by global brokerage CLSA, the recent default of Dewan Housing Finance (DHFL) on Rs 1000 crore dues can expose Rs 1 lakh crore in borrowing (from banks and mutual funds) to risk of default/haircuts.
With a shortage of funds and rising capital cost, NBFCs were forced to cut credit flow to sectors key to consumption — this brought India to an extraordinary crash in leveraged (auto, housing, consumer durables) consumption.
Mega savings drought
A deep dive in household savings data reveals the cause of declining demand of discretionary and staple items — the savings data (2013-18) suggests that household physical savings rate was partly replaced by consumption spending. Over the last few years, households have apparently gradually reduced consumption due to insufficient income growth.
In fact, the biggest hurdle for quick revival could be that India’s aggregate savings rate has seen a large and sustained decline since FY13 (by four per cent of GDP).
India has witnessed similar declines in previous downturns (FY00-02, FY08-10) — but those were modest and short-lived.
After a downtrend since 2010, bank deposits nosedived in the past one year with growth breaching below 10%. The low deposit growth is the result of structural and cyclical factors, such as constant moderation in nominal GDP growth and a change in households' behaviour from savings-focused investor to being a consumption-focused consumer.
Multiple slowdowns
The existing economic crisis becomes even more complex given the fact that multiple slowdowns — income, savings, liquidity stress — exist amid the mega consumption slowdown.
Income slowdown: With rural wage growth at the lowest in three years and unemployment at a 45-year high, the year-on-year growth in per capita income had reportedly touched its bottom in 2017-18 as per income estimates released by the Central Statistics Office (CSO) in January this year.
Savings slowdown: This is evident from the data of gross savings, bank deposits and physical savings in real estate.
Liquidity stress-driven lending slowdown: This is the top reason behind the slowdown in consumption. In FY19, the cost of capital apparently rose with a rise in currency in circulation. This is effectively a liquidity squeeze for formal finance. Alongside, the public borrowing rose, which further squeezed liquidity available to the private sector, leading to a further increase in capital costs.
Pain first — relief later
The complexity of the slowdown has put the RBI and the government in a quandary, forcing them to take measures that may aggravate the pain at the outset, before the revival happens.
In spite of three consecutive rate cuts by RBI, interest rates have been rising. As per the RBI’s release on lending and deposit rates, fresh lending rates increased by 5 bps in April 2019 to 9.8 per cent. This has reportedly led to 25 bps jump in interest rates for PSU banks. A shrinking deposit base and the tepid deposit growth are two key hindrances in effective transmission of rate-cuts. The market expects that interest rates transmission will be limited in contrast to macro factors and benchmark rate cuts.
The RBI has denied any direct or indirect lines of liquidity for NBFCs despite the fact that the government was willing to bail out shadow banks. The denial of liquidity to NBFCs may lead to further defaults in the financial system and make things worse for credit market and growth in the medium run.
Meanwhile, due to fiscal pressure and the possible contraction in revenues, the government will be forced to cut spending — which may lead to a further slowdown.
As far as policy intervention is concerned, to break the vicious cycle of a decline in private investment and savings rate both, the government will have to stimulate the economy by monetary and fiscal easing. A fiscal expansion (0.5-1 per cent of GDP towards infra, rural economy) supported by easier monetary conditions is highly desirable.
India's slowdown is a result of several vicious cycles working in sync — and we have no option but to live with it for at least the next 12-18 months before the greenshoots of revival come to the fore.
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