Cyclical or structural? Decoding the nature of India’s economic slowdown

Context:  A period of lean economic activity has been reported in the Indian economy. The decline in the growth rate of GDP embarks for introspection.

India’s real or inflation-adjusted gross domestic product (GDP) grew at 5 per cent in the June 2019 quarter of the financial year 2019-20 (Q1FY20), the slowest growth in six years. In nominal terms, the growth stood at 7.99 per cent, lowest since December 2002.

  • Lately, India is going through a phase of economic slowdown. Its GDP grew at 5% in the first quarter of FY20, marking the slowest growth since the fourth quarter of FY13.
  • In its annual report for 2018-19 released on 29th August, the Reserve Bank of India (RBI) had said that the slowdown was cyclical, rather than structural, which would have required deeper reforms.
  • The current slowdown is more than a cyclical one and of the structural type which is evident from the fact that the successive rate cuts by the Central Bank have not resulted in positive results.

Cyclical slowdown: A cyclical slowdown is a period of lean economic activity that occurs at regular intervals. Such slowdowns last over the short-to-medium term and are based on the changes in the business cycle. Generally, interim fiscal and monetary measures, temporary recapitalisation of credit.

Structural slowdown: A structural slowdown, on the other hand, is a more deep-rooted phenomenon that occurs due to a one-off shift from an existing paradigm. The changes, which last over a long-term, are driven by disruptive technologies, changing demographics, and/or change in consumer behaviour. Fixing such problems would require the government to undertake some structural policies.

The slowdown in the economy is an outcome of many factors:

Slowdown in consumption demand, the decline in manufacturing, inability of the Insolvency and Bankruptcy Code (IBC) to resolve cases in a time-bound manner, and rising global trade tension and its adverse impact on exports are some of the factors affecting India’s growth.

Consumption:

  • Private consumption, which contributes nearly 55-60 per cent, to India’s GDP has been slowing down.
  • While the reduced income growth of households has reduced urban consumption, drought/near-drought conditions in three of the past five years coupled with the collapse of food prices have taken a heavy toll on rural consumption.

Savings:

  • Savings by household sector – which are used to extend loans for investment — have gone down from 35 per cent (FY12) to 17.2 per cent (FY18).
  • Households, including MSMEs, make 23.6 per cent of the total savings in the GDP.

Investment:

  • Gross Fixed Capital Formation (GFCF), a metric to gauge investment in the economy, too has declined from 34.3 per cent in 2011 to 28.8 per cent in 2018, government data show. Similarly, in the private sector, it has declined from 26.9 per cent in 2011 to 21.4 per cent in 2018.
  • NBFC crisis triggered by IL&FS default led to a liquidity crunch in the economy.

Steps in right directions:

  • Subsequent rate cuts by RBI to lower the interest rate. The RBI has cut the repo rate by 110 basis points so far in 2019 to 5.4% – its lowest level since 2010.
  • Stimulus package announced by the government along with other measures may propel demand and thus help to recover the economy.
  • Surplus transfer by the RBI to the government can help boost planned-spending of the government without compromising fiscal deficit targets. It would also help in
    Recapitalising Public sector Banks to tackle the NPA crisis.
  • Merger of Public sector Banks would enhance the credit culture and thus spur investment in the economy.

Steps in the right direction,

Analysts say under the current macro environment, monetary policy seems to be less effective than fiscal policy as ‘improper transmission mechanism’ fails to pass on benefits to the real economy.

The Reserve Bank of India (RBI) highlighted a broad-based cyclical downturn in several sectors, including manufacturing, trade, hotels, transport, communication and broadcasting, construction, and agriculture, and called for counter-cyclical actions in terms of monetary and fiscal policies, along with deep-seated reforms for the structural slowdown.

Further rate cuts, increase in fiscal spending, deviation from fiscal deficit target, and boost in consumption sentiment are some of the suggestions by analysts to arrest the downtrend. On its part, the RBI has cut the repo rate by 110 basis points so far in CY19 to 5.4 per cent – its lowest level since 2010.

“There are structural issues in land, labour, agricultural marketing and the likes, which need to be addressed,” the central bank said in its Annual Report for 2018-19

Conclusion:

  • RBI, in its annual report, called for counter-cyclical actions in terms of monetary and fiscal policies, along with deep-seated reforms for the structural slowdown.
  • Stimulating domestic demand and reducing supply costs to maintain the Indian industry’s export competitiveness.
  • Economic Survey 2018-19 asked for taking measures to boost investment, especially private investment, that is the ‘key driver’ that drives demand, creates capacity, increases labour productivity, introduces new technology, allows creative destruction, and generates jobs.
  • Much needed structural reforms in land, labour and agrarian policies to tackle the structural dimension of the slowdown.

Steps to be taken:

  • RBI has called for counter-cyclical actions in terms of monetary and fiscal policies, along with deep-seated reforms for the structural slowdown.
  • Stimulating domestic demand and reducing supply costs to maintain the Indian industry’s export competitiveness.
  • The Economic Survey 2018-19 has asked for taking measures to boost investment, especially private investment, that is the ‘key driver’ that drives demand, creates capacity, increases labour productivity, introduces new technology, allows creative destruction, and generates jobs.
  • Indian economy needs structural reforms in land, labour and agrarian policies to tackle the structural dimension of the slowdown.

Way forward:

  • Giving the above scenario, reviving consumption demand and private investment has assumed the highest priority in the upcoming financial year.
  • Spending on infrastructure and implementation of much-needed structural reforms in the areas of labour laws, taxation, and other legal reforms will enhance ease of doing business in pursuit of fulfilling the vision of India becoming a $5 trillion economy by 2024-25

Economists said the slowdown is cyclical but deep-rooted and some structural reforms will be needed to ensure that growth gets back on track