Engines of economy need urgent attention

The latest monthly economic report of the Department of Economic Affairs of the Finance Ministry has some worrying trends. The economic growth for the past three years has declined from 8.2 to 7.2 to 7.0 percent. The latest quarterly growth rate is 6.6 percent, and the January to March quarter data will be published in a couple of weeks. So, this declining trend continues, and for the fourth year in a row, India will register a downward trend. We may not even retain the title of the fastest growing large economy in the world, since Chinese growth could be slightly higher.

The second worrying trend for the past three years is the decline in gross value added (GVA) in agriculture from 6.3 to 5.0 to 2.7 percent. Food price inflation during 2018-19 was lowest since 1991 as per a report by CRISIL. The items like fruits, vegetables, pulses and sugar had negative inflation i.e. deflation for a significant part of last year. The rural wage growth has been below five percent for the past several years. This has impacted rural demand, and hence the performance of businesses which depend on robust rural demand. These include industries like fast moving consumer goods (soap, toothpaste, hair oil, biscuits) and also two wheelers (scooters).

Adding to the challenges of a three-year widening trend of the current account deficit is the fact that the Indian currency got stronger in real effective exchange rate terms in the last three months, as per the government’s monthly report. Incidentally the second highest item of imports after crude oil, is electronics items, including mobile phones.

The Chairman of the iconic company Hindustan Unilever said “You can’t say FMCG is recession proof, but it is recession resistant” in a press meeting to discuss the results of his company. The revenue growth of the company is at the lowest in nearly two years, and the impact is seen in the sale of consumer staples in rural areas. Clearly the slowdown in value added in agriculture is hurting the sale of FMCG. The monthly growth of two wheelers has been declining for more than a year. It is in negative territory now, at minus 20%. The worst affected are scooters, which had a negative growth in the last year (Fiscal Year 2018-19), for the first time in 13 years.

The third worrying trend from the Finance Ministry’s report is the steady rise of the current account deficit in the last three years, from 0.6 to 1.9 to 2.6 percent of the GDP. The 3 percent level is the danger mark, breached in the crisis year of 1991 as well as the “rupee panic” year of 2013. This means our exports earnings are unable to bridge the gap due to rising imports. Over five years since 2014 to March 2019, the net growth in exports was zero. Exports are highly correlated with domestic manufacturing activity. The index of industrial production (IIP) as per government data has turned negative in March, and has been declining for four months. Particularly worrying is steeply negative growth in the production of capital goods, with the March index showing negative 8.7. Adding to the challenges of a three-year widening trend of the current account deficit is the fact that the Indian currency got stronger in real effective exchange rate terms in the last three months, as per the government’s monthly report. Incidentally the second highest item of imports after crude oil, is electronics items, including mobile phones.

The fourth worrying trend is the stagnation in capital investment as a proportion of the GDP. That ratio is stuck at 28 percent or so, when it has been above 35 percent in the past. The growth in private investment spending is also nearly zero. This means that new capacities are not being created, newer business ventures not being launched. As a result of declining investment ratio, the potential GDP of India has probably dropped from 8 to 7 percent per year. Which means that anything above, will cause the economy to overheat. Speaking of overheating, both the consumer price based and wholesale price-based inflation is on an upward trend. The Ministry’s report also points to the fact that the GDP deflator (another proxy for inflation) is also going up.

The economy needs four engines; consumption, exports, investments and the government to keep it going. Of these, the latter’s contribution has fiscal constraints. India’s fiscal situation is better than five years ago, but no cause for comfort. With new obligations like universal income, health insurance and loan waivers, in addition to the need for recapitalising public sector banks, the government cannot be expected to pump prime the economy indefinitely.

Clearly the economy should be high on the priority of the incoming government. One of the members of the Prime Minister’s Economic Advisory Council, warned that India is at the risk of falling into the middle-income trap. Dr. Rathin Roy said that the long-term trend in the past two decades has been that India has not been an export driven economy unlike South Korea or Japan. It has relied on domestic consumption growth. But that growth has catered mainly to the goods and services demanded by the top 100 million customers. That includes cars, scooters, air travel, all of which used to exhibit strong double-digit growth. But that demand is faltering. Maruti Suzuki, a bellwether for auto demand and manufacturing, saw its volumes dropping by 17 percent in April, the sharpest drop in seven years. Even domestic air travel came down to a zero growth in March, partly of course due to the shutdown of Jet Airways. But this halt came after four years of double-digit growth, the highest in the world. Dr. Roy opined that either consumption growth should become broad-based, or exports needs to shoulder the burden of revving up the economy.

The economy needs four engines; consumption, exports, investments and the government to keep it going. Of these, the latter’s contribution has fiscal constraints. India’s fiscal situation is better than five years ago, but no cause for comfort. With new obligations like universal income, health insurance and loan waivers, in addition to the need for recapitalising public sector banks, the government cannot be expected to pump prime the economy indefinitely. No doubt the large expenditure on roadways, railway and waterways will have long term spill over benefits, but there is limited scope, if we are focused on 8 plus percent inclusive growth. An earlier version of this column laid out the agenda for the first 100 days of the new government, which included filling a large number of government vacancies and addressing rural distress. Alongside the short-term priorities, we also need to work on reviving the twin (consumption and investment) engines if not all four, for the economy.

(The writer is an economist and Senior Fellow, Takshashila Institution)