Putting the FM speech in perspective

Speeches in Parliament are meant to be political in nature as they normally involve debates which address the opposition. Hence the FM’s address in the Rajya Sabha on Wednesday must be looked at from this perspective. Comparisons with previous regimes is relevant from the political side though is of less importance when it comes to sizing up the current state of the economy.

There is an interesting point that the FM made relating to a recession which needs discussion. A recession is technically a situation where an economy registers two successive negative growth rates in GDP which means output is really falling as distinct from a situation where the rate of growth has slowed down, which is the case today. The FM has also ruled that such a situation can never happen in India which is right in a way, though it cannot be ruled out, especially if the world moves into a 1930s-like depression. But the broader question is whether this is enough and reassuring?

There are three important points to be made here. The first relates to the state of the economy which is disturbing. Post demonetization there has been a distinct slowdown in the economy which has gotten magnified today with GDP growth slipping to a sub-5% level on a quarterly basis. What is striking today is that the three engines that need to fire either together or individually are dormant.

Consumption growth has been affected by low growth in employment and limited increase in household income. To top it, the continuous decline in interest rates on bank deposits has meant that the population that is fully dependent on interest income has had to cut down discretionary spending which has affected overall demand.

Investment has become stagnant and is at around 28-29% of GDP. The reason is that there is surplus capacity in most industries and with demand slackening over the last three years, there is less incentive to invest. Infra investment has little interest with both the demand and supply sides being dormant. Private sector investment has been low as with several large NPA cases under the IBC in segments like power, telecom, metals etc. which have become less attractive. On the supply side, banks are not too eager to finance infra investment and have preferred to go the retail way. Hence while the FM has rightly spoken of the positive steps taken by the government to recapitalize banks and make them stronger with RBI liquidity support, the willingness of banks to lend is still in limbo as the NPA overhang is a stern reminder of the asset quality issue.

The third engine is government which has gotten into a tangle due to low growth where revenue collections are missing their targets. There is a constant struggle to control the level of fiscal deficit and in this quest there may have to be capex cuts by the end of the year. The recent corporate tax giveaway will increase the deficit by at least 0.5% which is a concern. While disinvestment target will be met as the FM has made the announcement on the same recently, the same cannot be said about tax revenue.

In fact, GST is a concern and shortfalls here will also impact state finances especially if the 14% guaranteed amount is not provided to them. This can hence impact their budgets and capex.

The second point is that the government has actually done almost all that is required to help the economy and the over 30 announcements that have been alluded to by the FM are all positive measures. However, their impact will be felt only over the next couple of years as most of them are in the nature of improving business environment or correcting certain policies especially in the auto sector. The corporate tax cut and the real estate AIF to be set up probably are the only measures which actually involve money. Therefore, the reforms that have come in would yield result in the medium run and will have little impact this financial year. In fact, even for the corporate tax rate cut, most companies that have used the lower rate are likely to pay higher dividend or repay debt rather than go in for investment right now.

The third is the RBI too has already lowered rates by 135 bps and another cut cannot be ruled out. But the effect of such rate cuts has not been found in higher borrowings or investment and will not be because the environment is not conducive. Therefore, even on the monetary side there are limits to which policies work.

Hence, the economy is in a low equilibrium trap and this has been structural in nature. The upward path will be gradual. While the FM is right about the recession, the disturbing factor is that there does not appear to be any quick fix solution. The government and RBI have one their bit and the time taken henceforth for these measures to work out will be critical. Practically speaking it can take another two years before the economy moves towards the 7-7.5% growth rate and for FY20 it is likely to be less than 6% for sure and could be more like 5.5% with a downward bias. This would be a fair assessment of the state of affairs.

The writer is chief economist, CARE Ratings.

Views are personal.

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