By Snigdha Kalra
GDP growth in India has entered a slump. In the first quarter of 2017, the growth rate of GDP fell to a three year low of 5.7%, down from 6.1% in the preceding quarter of January-March. This is the lowest growth rate recorded since 2014 when it touched a record low of 4.6%. Some believe that this slowdown is the impact of a lingering effect of demonetisation and the destocking activities of the manufacturing sector in the run-up to Goods and Services Tax (GST). Others say that the GDP growth had been on a downward spiral even before these disruptions due to a fall in investments. However, various factors have been at play in the run-up to this downturn, and it has been the cumulative impact of them all.
Recent disruptions
Demonetisation and GST have been the two biggest disruptions to the Indian economy in recent times. Implemented within the course of one year, they have been major contributors to the economic slump that India is facing today. The exercise of demonetisation had the biggest impact on the construction and financial service sectors. The informal sectors have also been impacted by a fall in liquidity and a cash crunch.
The impact of the new tax regime has led to a slowdown in the manufacturing sector, which has recorded a five-year low growth rate of 1.6%. This is a result of destocking by this sector in anticipation of GST. No new manufacturing activities having been carried out as well.
Moreover, the current Non-performing Assets (NPAs) crisis has also resulted in a fall in credit growth, which has led to a further slowdown in investments. NPAs or bad loans refer to those loans which are at risk of default. The percentage of NPAs with banks in India stood at 10.21% in June 2017, posing a threat to the banking system.
The underlying factors
The current adversity is not just a function of the disruptions mentioned above. It has been in the offing for a while now. GDP growth rate has been declining for the past six quarters, even before demonetisation was implemented. Despite a low level of inflation and fiscal deficit, implying a steady economy, productivity indeed declined.
The major underlying cause is the loss of investor confidence. Following a sweeping victory of the Bhartiya Janta Party (BJP) in 2014, optimism was high in the markets, in response to the reformative agenda of PM Narendra Modi. Thus, investments rose multifold and financial markets were bullish. However, this agenda has yet to attain real, revolutionary results, two years after the BJP came to power. Thus, the initial optimism has subdued now, which has led to a slowdown in investments.
Moreover, the current NPA crisis has also resulted in a fall in credit growth. Banks are suffering from a huge amount of stressed assets, and are not willing to lend to untrustworthy borrowers with the risk of default.
Another factor comes into play here. Despite inflation being at a record low, the RBI is not ready to make a huge cut in interest rates, citing upside risk to inflation. An adequate fall in interest rates could make investments attractive, but that has not been part of the strategy so far.
According to a report by Kotak Institutional Equities, a weak investment demand is a bigger structural challenge than the short-term impact of the recent reforms. A revival of investment demand needs to be focused on, more than GST or demonetisation, as it will impact the economy in the long run unless investment is stimulated by structural measures.
Chances of recovery?
A report by Morgan Stanley says that, although growth has suffered due to GST related disruptions, the GDP statistics do not reflect underlying growth trends in the economy, and rate of growth will recover as the economy stabilises from disruptions. In our view, India is moving on to the next phase of the business cycle of productive growth – a phase marked by further improvement in growth while macro stability remains in check. This will also set the stage for a sustained growth cycle, said the report. It predicts a growth rate of 7.4% in 2018.
Whether these predictions turn out to be true, or India plunges deeper into a slump, will depend on how the government and RBI respond to the situation.
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