India Shining was
a marketing slogan referring to the overall feeling of economic optimism in
India in 2004 but the sheen might well have disappeared. The economy grew at 5%
in the last quarter for which data is available, leading to a rash of downward
recalibrations of growth for the full financial year. India’s ranking as per the annual report of The World Bank improved
to 63rd, up from 77th last year. Yet if major indicators are to be believed, its
economy is slowing down rather sharply.
Narendra Modi came
to power in 2014 on the back of the promise that if elected, he would make of
India an economic powerhouse that would rival China. This year, after being
re-elected, he pledged to turn India into a $5 trillion economy, nearly twice its current size, by 2024. However, it seems promises will
remain just empty promises especially considering that the economy is in a shamble,
buffeted by the twin shocks of demonetization and implementation of the GST
gone horribly wrong among others.
This slowdown has,
inevitably, affected the disposable income of households, so that the increase
in private consumer expenditure has witnessed a slump, dampening growth further
from the demand side. Household consumption has fallen since Prime Minister
Narendra Modi entered office in 2014, something that hasn’t happened in “many,
many, many years.” The immediate cause of the demand slowdown may have been the twin blows
of demonetization and the new indirect tax regime, as well as the collapse of
shadow banking credit last year. The consequences for the
automobile sector, which is the driver of manufacturing, and for construction,
which is an important source of employment creation, are now being felt.
The fundamentals of the economy,
except for the moderate consumer price inflation, are worrisome. Investment
rates as a percentage of GDP are progressively lower. So are savings rates. The
stagnation in the dollar value of exports continues. The problem is apparent
even to those with a rudimentary understanding of the economy. Stimulation in
private investment was the rationale behind the reduction in the corporate tax,
by as much as ten percentage points. But theory and experience both suggest
that tax cuts work with a time lag and do not ever lead to an equivalent
increase in investment.
Higher profits emanating from
lower taxes could be used by firms to restructure debt and clean up their
balance sheets, increase dividends paid to shareholders, or reward senior
management with stock options and directors on their boards with commissions.
In the present situation, where firms are saddled with high debt-equity ratios,
stock markets are nervous, and corporate behaviour on pay outs is what it is,
all three could happen. Hence, higher profits will not lead to a pari passu
increase in investment. In fact, this increase might be a tiny proportion of
the enlarged profits, particularly if business confidence remains low.
The Indian economy is facing a
perfect storm, beset by a combination of cyclical and structural factors that
makes recovery doubly difficult. The immediate concern is crashing demand. But
there is a deeper problem as well: Promoting consumer demand should never have
been considered a sustainable growth model in the first place. Instead, India
should have been focusing on encouraging greater levels of private investment.
This reflects a broader
unwillingness to confront the structural problems in the Indian economy. Many
believed that with the advent of the BJP-led government there would be a stimulus
in the economy and a revival in growth. Instead, fundamental problems are being
exacerbated.
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