Is the economic slowdown for real?

It has been a torrid two months for Indian investors with financial markets getting extremely turbulent since Budget 2019. Market sentiment worsened significantly thereafter with President Trump ratcheting up the trade war with China. And macro data has only added to investors’ woes.

Institutions such as the IMF have been warning about the trade war impacting global growth. And recently, with the yield curve inversion in the US, the ‘R’ word has been doing the rounds as well. There have been several instances in the past when recession has followed an inverted yield curve.

The Indian economy has also been displaying signs of stress for a while; the June quarter numbers have provided fuel to all the doomsday predictions, with the GDP reading at a 25-quarter low. News about slowing sales, piling inventory, plant shut-downs, lay-offs etc have become more frequent.

The questions being posed by people now are: how serious is the slowdown ? Is it just a passing phase or will it sustain? Are we headed towards a recession?

Heading towards a recession?

To answer these questions, we have to first understand what a recession is. There is no standard definition of recession. But the most popular is the one by the National Bureau of Economic Research of the US, which describes recession as a period of significant decline in economic activity spread across the economy — lasting more than a few months — which is normally visible in real GDP (gross domestic product), real income, employment, i ndustrial production, and wholesale-retail sales. There are others who view decline in real GDP for two consecutive quarters as a recession.

The consequences of a recession could be pretty dramatic. Sharp fall in consumption and investments, higher unemployment rates, lower wages and rise in income inequality are a few. Also, it takes a country many years to recover from the effects of a recession.

The 2008 recession, that dealt a severe blow to global growth, is the most recent one in history. Caused by the sub-prime mortgage issue leading to a collapse of the real-estate market in the US, the recession lasted from December 2007 to June 2009.

During that period, the US economy experienced five quarters of decline (Q-o-Q) and one quarter of slowdown in the GDP growth. India recorded one quarter of negative growth, four quarters of slowdown and one quarter of growth.

This period was officially termed as recession for the US economy, going by the technical definition. But India experienced only a slowdown as the economy revived quickly, thanks to the Centre’s fiscal and monetary stimulus.

In fact, India has not experienced a recession in recent history, going by the above definition. But there were times when the country witnessed slowdown in about two to four quarters. In 1991, on account of the spike in global oil prices; in 1997, due to the Asian financial crisis; in 2000, because of the dot-com bubble (or the tech-bubble), in 2008-09, in the wake of the US’ financial crisis and, briefly in 2011, which could be attributed to business cyclicality.

So, is India going through a recession or a slowdown now? Going strictly by the definition, India may not be in a recession yet. If we consider the GDP growth alone, there have been four quarters of slowing growth. But the GDP growth is still at 5 per cent (real GDP is still growing and has not declined) and far above the low of about 3 per cent recorded in 2008.

However, it is important to understand whether the pain will continue and for how long. A closer look at the components of GDP can throw some light.

Fall in investments

Let’s begin with gross fixed capital formation (GFCF). GFCF constitutes about 30-32 per cent of GDP and represents investment activity of the government as well as private players. GFCF grew by 4 per cent Y-o-Y in Q2 calendar year 2019, with an average of 3.8 per cent in the first half of 2019. This is sharply lower than the average growth of 12.15 per cent in the four quarters of 2018.

The slowdown in this component in 2019, however, to an extent, has been due to the high base effect. The Centre had stepped up spending on roads and Railways in 2018.

Higher spends were seen in the significant increase in the number of road construction projects awarded by the government in FY18 (nearly doubled in terms of kilometres to be constructed) and high inflow of bulk orders received by manufacturers of rail wagons in FY19.

Apart from the high base effect, the subdued growth in the government’s capex this year can also be attributed to weak activity amid general elections and muted tax collections.

Private capex has been muted for a while and the liquidity crunch in the aftermath of IL&FS crisis, could have further hampered growth.

Going ahead, the government spends can improve. The Budget proposal to invest ₹100-lakh crore towards infrastructure in the next five years, and an estimated funding of ₹50-lakh crore till 2030 for developing railway infrastructure, if speeded, could help. The surplus transfer from the RBI this calendar year will ensure that the Centre does not cut back its capital expenditure in FY20.

But investments from the private sector could take longer to revive, given the weak domestic and global demand.

No slowdown in govt expenditure

The government final consumption expenditure (GFCE), constituting about 10 per cent of GDP, includes administrative expenses of the government and the value of goods and services provided for public consumption. GFCE grew by 8.8 per cent in the quarter ending June 2019, with an average of 10.95 per cent for the first half of of 2019. This is against the average of 11.28 per cent recorded for all the four quarters in 2018, indicating that there hasn’t been much of a slowdown in this segment.

It is to be noted that this component of GDP does not have any particular trend and may not be a key driver of the country’s economic activity.

Consumption in doldrums

The private final consumption expenditure (PFCE) that accounts for about 55-58 per cent of GDP represents personal consumption in the economy. The PFCE recorded a growth rate of 3.1 per cent Y-o-Y — at 18 quarters low — in the second quarter of 2019 and caught everyone by surprise. The average growth rate for the first half of the year was 5.15 per cent against 8.5 per cent for 2018.

A number of factors seem to have affected consumption. Weak growth in rural and urban income in recent years has made retail customers turn increasingly towards leveraged purchases for discretionary spends such as autos, consumer durables, real estate etc. The NBFC segment had emerged as a main source of financing for bulk of these loans between FY13 and FY18.

However, in the aftermath of the IL&FS crisis, as many NBFCs stopped disbursing fresh loans, the demand for these items dried up, leading to inventory piling up and job losses in some segments. The MSME segment that had already been hit by GST roll-out and weak demand environment was further hurt by the credit tightening.

The RBI’s rate cuts to the extent of 110 basis points in the current calendar year have not helped in spurring demand.

The troubles in the auto segment have been the most commonly cited example for consumption slowdown. But the industry has many other issues that resulted in volumes declining 13.9 per cent Y-o-Y in the April-July 2019 period.

Commercial vehicle (CV) sales were hurt by the GST regime ushering in quicker turnaround time for CVs and the permission granted to CVs to carry higher loads. Increase in mandatory third-party cover and stricter road safety norms also pushed up the price of vehicles. Transition to BS-VI compliance vehicles by April 2020 is further affecting sales in this sector.

The woes of the auto sector looks cyclical rather than structural. According to SBI, the sector slowdown in India is not an isolated phenomenon; this is happening in other Asian countries as well — China, Indonesia and Malaysia.

Fall in banks’ consumer durable loans (-71.5 per cent Y-o-Y as of June 2019 vs 17 per cent last year) and weak consumer confidence are other manifestations of tight credit condition.

The silver lining is that while the PFCE growth was sharply lower in the June quarter, it averaged a decent 7.2 per cent in the preceding six quarters.

Once the liquidity issue is addressed, with the recent stimulus measures, if credit offtake improves, things may look up for most industries. Better monsoon this year also means improved rural demand. It might therefore be better to see the trend in consumption for another three to four quarters before deciding if the slowdown is structural.

Volatile export growth

Net exports (exports-imports) is the fourth component of GDP. As India’s imports are always higher than exports (leading to negative net exports), there were hardly any periods in the recent past when net exports positively contributed to GDP. The net exports are equivalent to negative 3 per cent of net GDP.

While exports growth dropped to 5.7 per cent in Q2 2019, as against an average of 10.6 per cent in 2018, imports growth also decelerated to about 4.2 per cent from 16.15 per cent average growth.

The uncertainties in the global market could have stagnated international trade.

Having said that, imports and exports depend on various factors such as nature of the product/service, value of currency, protectionist measures, applicable tax rates, domestic supply, trade relations and internal and external political conditions. The growth curves of exports and imports have always been volatile and cannot be used to evaluate the domestic economic condition.

That said, it was observed that net exports in value terms have been falling from the second quarter of 2017, widening the trade deficit. Lower exports in labour-intensive sectors such as gems and jewellery, textiles, leather, and agri-related products, have increased the risk of job losses.

Other red flags

The impact of lower investments and weaker demand during the quarter was evident in the subdued manufacturing and construction activities. Manufacturing segment has been the worst performer with only by 0.6 per cent growth in the latest June quarter against an average of 8.73 per cent during 2018.

Agriculture sector grew 2 per cent Y-o-Y in the April-June quarter. While this was higher than in the March quarter, it is much lower than the average 4.83 per cent growth in 2018. Agri-output of some food and non-food crops has been sliding over the last one year and is apparent from the increasing food inflation from the start of this fiscal.

Tepid growth in the rural and urban income — factors directly impacting personal consumption — is worrying. Stagnating growth in retail loans is another spoiler.

Not down and out

There were certainly signs of slowdown in the first half of 2019. Private consumption growth has plummeted and fixed capital formation has slowed considerably.

Weak growth in rural and urban wages, job losses in the auto sector, slowdown in labour-intensive sectors, and decline in disbursal of consumer loans have affected public sentiment. This, coupled with general elections, tight liquidity conditions, business cyclicality and uncertainties in global trade, have hit growth.

While the state of the economy appears shaky now, the slowdown can be contained. Private consumption can be revived if liquidity is made available and distress in key employment intensive sectors are addressed.

Going forward, good monsoon, stimulus measures and festive season could help revive demand to some extent. If the Centre concentrates on executing budgeted capital spends, that too can provide a kicker.

If we look at the domestic factors in isolation, the situation is not irreparable. But we need to take cognizance of global uncertainties at this point. If there is a severe slowdown or recession in leading economies such as the US and China, India cannot escape unhurt. Also, the Brexit factor could disrupt global conditions in the months ahead.