3rd September – Is the slowdown cyclical or structural?

The slowdown is cyclic, aggravated by a focus on structural reform, that neglected responding to a slowdown in industry and investment evident since 2011.

slowdown cyclical or structural

Details –

  • There were structural features, such as constraints in agriculture, that kept food inflation high. But industry paid a disproportionate and unnecessary cost, since real interest rates were raised to the highest-ever historical levels to fight food inflation, for which their effectiveness was limited.
  • The financial sector and foreign investors favoured the conservative monetarist stance, because they value macroeconomic stability, but perhaps they did not realise that excessive tightening also creates risk in Indian conditions.
  • The growth that was lower than the potential for almost a decade hurt investors also. Despite the noise about deficits and inflation, research shows that the country ratings are most strongly associated with per capita output, which depends on growth.
  • As real appreciation and high-interest rates damaged the domestic industry, the economy’s import dependence increased. As oil import dependence sets a floor to rupee depreciation, stimulating domestic demand and reducing supply costs to maintain the Indian industry’s export competitiveness is particularly important.

Tight liquidity –

  • High real interests aggravated and sustained NPAs. Highly leveraged firms find it difficult to repay, more so if earnings fall since demand is kept low. An asset quality review cannot help when assets keep deteriorating.
  • The decision to keep durable liquidity in deficit since 2011 aggravated matters. The deficit often became too large, since the Indian economy is subject to large liquidity shocks, for example from movements in foreign capital.
  • Those who question the Indian GDP estimates find it puzzling how growth reached 8.2 in the year after demonetisation. But this was precisely the period when banks and mutual funds were flush with funds, which they lent to NBFCs who on-lent to firms and consumers. The availability of liquidity was an important growth enabler.
  • By 2018, durable liquidity had become tight again, partly due to foreign outflows. It was unfortunate that this tightening coincided with the problems in IL&FS, that severely constrained funding to NBFCs. The current slowdown started in the second half of 2018, with the tightening of aggregate and sectoral liquidity. It follows that a reversal can ameliorate it.

Reduction in investments –

  • Government spending in the second half of 2018-19 was lowered by about 2 percent of the GDP in order to meet fiscal deficit targets. This government tends to front-load spending and to spend more in the first half of a fiscal year.
  • Private investment also slowed, partly due to pre-election uncertainty, while the global slowdown affected exports. Falling incomes, as well as credit, slowed consumption.
  • The liquidity deficit turned surplus only in June, after one year. The long squeeze had left pockets empty. There were hardly any real estate transactions. The consumption and growth slowdown is not surprising.

A good signal –

  • The good news is that these conditions are changing. Monetary policy has finally become accommodative, liquidity is in surplus, many schemes are making it easier for NBFCs to get liquidity, and there are signs the government is front-loading spending again since July.
  • The transfer from the RBI is only 0.75 of the GDP, but can help jump-start planned spending through a rise in money supply, without forcing the government to borrow ahead of revenues and thus raise G-Sec interest rates.
  • The Finance Commission may relax the FRBM to enable counter-cyclical spending. Privatisation can transform government assets into infrastructure, which has more spillovers. The festive season should see some cheer.

SourceThe Hindu Business Line

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