Indian Economy Slowdown – Cyclical or Systemic?

Last week came the sombre news that India has slipped one rank in the World Bank’s Gross Domestic Product (GDP) rankings of 2018. It is now the world’s 7th largest economy (see table).

This data should be seen in the context of the announcement of the Government of India to make India a $5 trillion economy by 2024. Earlier, India lost the tag of the fastest growing economy to China. This is a definite dampener on the joyous mood of the NDA government which returned to power with a thumping majority and also gives them little space for an excuse to blame “yesterday’s” regime for “today’s” economic mess. However, it will be pertinent to examine if the slowdown is cyclical or systemic as it would help us assess the path required for coming out of this quagmire.

Slowness everywhere

Fast moving consumer goods (FMCG) giants like Hindustan Unilever, ITC and Godrej are reporting lower growth. Domestic air traffic growth is going down. Rail freight traffic is less than the average of previous five years. Real estate is piled with stock of unsold buildings that is almost 7 years old. The automobile industry employs more than 3.7 crore people and has nearly 7% share in the nation’s GDP. With 500,000 passenger vehicles and 30 lakh two-wheelers waiting to be sold, these manufactured products are adding to the inventory costs and bringing sales to eight-year lows.

Maruti Suzuki – one of the country’s largest makers of cars and four-wheelers – is planning to operate in single shift mode across all its manufacturing plants. It is estimated that this slowdown in the auto industry is resulting in a job loss of around 350,000 workers. Export growth took a nosedive and reached a 3.5-year low with a negative growth of 9.7% in June this year. With petroleum, rice, cotton-yarn, fabrics, gems & jewellery, chemicals and engineering goods – all registering sub-zero growth, the export front paints a very dismal picture and poses a huge challenge for the economy where domestic demand has been extremely sluggish with no immediate signs of revival.

The usual suspects and some more

Demonetisation, GST, global-slowdown and agrarian crisis have long been blamed and correctly so for the sputtering of India’s economy. However, there are some other very important reasons that need to be probed further to comprehend what is happening. Samiran Chakraborty – Chief Economist India – Citigroup Global Markets gives a very interesting acronym to India’s economic problem at the structural level. He calls it the problem of the 3 D’s. Demand (lower aggregate demand), Debt (corporate) and Default (NPAs of banks). There has been a slowness in consumption levels since 2017.

Macro (household savings) and micro (sector and company volume) data indicate that households might have reduced their consumption due to low income growth. Money supply (M3) which essentially is made of narrow money (coins and notes in circulation) plus other money equivalents that can be converted easily to cash along with short-term time deposits in banks and certain money market funds in addition to long-term deposits – has lagged behind the growth in GDP since 2016.

One of the principal reasons for lower consumption then appears to be a lack of liquidity and not enough money supply. According to Neelkanth Mishra of Bloomberg – “The engine that converts the 28 trillion rupees of base money (M0) to the 154 trillion rupees available as broad money (M3) is malfunctioning. The bottleneck is in the financial system. Money gets created when loans are given and, even though bank credit growth has accelerated in the past few months, aggregate credit growth is still far too weak.”

Another issue that has been lurking around is India’s “Twin Balance Sheet” (TBS) problem. Due to lower demand, corporates are not seeing growth and are unable to repay loans. This affects the banks’ balance sheets and hence their ability to loan more to the other corporates. The positive effect on growth because of boost to salaries to government employees with the last pay commission seems to be declining and the shadow banking slowdown accentuated by the fall of IL&FS has lent a body blow to any hopes of an immediate revival in growth and demand.

The way out

Obviously, the correct path to bring back higher growth is by boosting investment, increasing consumption, delivering job growth and improving rural incomes. And all this keeping in mind fiscal discipline and providing welfare and subsidies for the poor and underprivileged. In an interview to PTI, former RBI Governor Bimal Jalan asserted: “The slowdown in the growth is cyclical. In one or two years, I am sure, there will be a turnaround.”

This essentially means that India is currently passing through a contraction phase and will bounce back into the expansion phase. In a period of contraction, growth slows, unemployment increases and prices stagnate. During the expansion phase, there is rapid growth because of high consumption, lower interest rates, increased production and inflation starts building up. Systemic problems in the banking and shadow banking sector have to be rectified and liquidity and credit supply to the market has to be increased.

Alternative Islamic Economics

In an era where both classical and neoclassical economics have run out of steam to navigate the economies of countries and meeting their requirements for delivering policies and methodologies that guarantee economic prosperity and fiscal stability, there is an acute need to come up with a new paradigm in “Alternative Economics” which looks at both sustainability and practice of ethical standards whilst framing economic choices for markets, governments, financial institutions and regulators.

Islamic Economics has the potential to meet the aforesaid requirements but requires introduction in academia and policymakers that is backed by both practical propositions and academic rigour. This new paradigm in alternative economics needs to be conveyed to the people of India and especially those who shape public opinion and policy in the domains of governance, finance, economic policy and economic reform. This should end both the cyclical and structural problems of India.