Understanding India's economic slow down
- August 26, 2019, 10:43 am
Why India's economic growth is slowing down
The slowdown in the Indian economy is evident now as indicated by multiple data points. All leading indicators of the economy -- domestic consumption, credit offtake, imports -- point towards a slump in the economy. Auto companies reported their steepest fall in sales in July after reporting their worst quarterly fall since 2000-01 in the April-June quarter of this fiscal. Honda Cars India reported a whopping 49% decline in July car sales while Maruti Suzuki, India's biggest carmaker saw sales volume declining by 37% in the preceding month.
Consumption, which is the main life-blood and the driving force of the Indian economy, has visibly slowed down in the recent months in the absence of credit supply to the informal sector and weak rural economy. In the month of June 2019, imports fell by 9.1% with the biggest drop seen crude oil import, machinery and uncut precious stones, reflecting sluggish domestic demand. NBFC, which used to be the prime lender to the informal sector, are reeling under liquidity crisis.
India's GDP growth which fell to a five-year low of 6.8% in the previous fiscal (FY19), is also likely to be muted in the current financial year as well. Multiple global agencies including the International Monetary Fund (IMF) and Asian Development Bank (ADB) have slashed their forecast for India's economic growth. Credit rating agency Crisil on Thursday lowered India's GDP forecast by 20 basis points to 6.9% for the current fiscal (FY20). Economists say there are various factors responsible for pulling India's economic growth lower. Here are five key reasons for the slowdown in the Indian economy:
1) Lower farm income: Economists say lower growth in farm income is a major factor behind the slowdown in consumption. According to data published by Crisil, in the financial year 2018-19, growth in rural wages was 3.7%. This was sharply lower when compared to the average wage growth in the previous five years. The average growth in rural wages between FY 2013-14 to FY 2017-18 was 10.8. However, farm income could get a leg-up in the coming years due to the income transfer scheme announced by the government. Experts believe that the recently announced measures by the government are still not sufficient to push up farm income. Government data shows total private consumption growth, a key element of GDP, has fallen to 7.2% in the Q4 of FY19 from 9.8% in Q2 of FY19.
2) Falling industrial growth: According to rating agency Icra, the performance of early economic indicators was unfavourable in June 2019, with as many as 12 of the 16 indicators displaying a deterioration in annual growth. Indicators such as aviation turbine fuel (ATF) sale, port cargo, two-wheeler sales, commercial vehicle sales, fell on a year-on-year basis in the month of June 2019, indicating industrial growth has taken a toll in June 2019.
3) Monetary and fiscal policies: When the Narendra Modi government came to power in 2014, both inflation and fiscal deficit (combined deficit of the Centre and states) were at an elevated level. To bring the situation under control, the then RBI Governor Raghuram Rajan focused the monetary policy primarily to control inflation, which was also followed by his successor Urjit Patel. Between 2013-14 and 2018-19, CPI level fell from a high of 9.4% to 3.4% but the average repo rate during this period remained elevated at 6.5%. Due to which real interest rates were high and it discouraged corporates from making fresh investments, which dragged growth further. Meanwhile, the government also remained committed to fiscal discipline to lower fiscal deficit which left little room for the Centre to increase spending to pump-prime the economy, say analysts.
4) Global headwinds: With the US targeting China, the world's second-largest economy, by imposing tariffs on Chinese imports, most other economies got affected. Worth mentioning here is that China's GDP in the second quarter of 2019 fell to a 27-year low of 6.2% amid demand slowdown. In the first six months of 2019, China's economy grew by 6.3%. This also impacted India's exports. In the first five months of 2019, India's exports to China fell by 1.62% to $7.70 billion. It may be noted that China is a major trade partner of India. The slowdown in the Chinese economy is also affected India's bilateral trade with other economies like the UAE and Hong Kong. The US sanctions against Iran have also added to global economic turbulence.
5) Stress in the financial sector: The overall NPAs in the banking sector jumped to 11.2% in 2014 due to which RBI imposed lending restrictions on weak banks and due to this credit to corporates slowed, which impacted private investment. No sooner did the NPA ratio started improving in the fiscal year 2019, the NBFC stress started building up. With multiple defaults by infrastructure lending firm IL&FS, banks (both private and public) put a brake on lending to the shadow banking sector, affecting credit to the informal economy, which was gradually recovering from demonetisation and GST implementation. Worth mentioning here is that stress in NBFCs percolates faster than PSU banks because of its greater interconnectedness to mutual funds, banks and SMEs.
In July, the sale of vehicles across categories in the country slumped 18.71% to about 18.25 lakh units, down from about 22.45 lakh units, a year ago in the same month. This has been the steepest fall in nearly 19 years. This data, by the Society of Indian Automobile Manufacturers (SIAM), gives out wholesale figures — i.e. the number of vehicles dispatched to dealers by vehicle manufacturers. The passenger vehicle segment, which comprises cars, utility vehicles and vans, has been one of the worst-performing segments, registering its highest drop in sales since December 2000: almost 31%, to a little over two lakh units from nearly 2.91 lakh units in July 2018. This was also the ninth straight drop in monthly passenger vehicle sales. In fact, barring a low single-digit uptick in October 2018, segment sales have been falling for the past year. With the industry failing to arrest the downturn that started almost a year ago, despite deep discounts and new model launches, it has been forced to undertake production cuts. This has also led to the trimming of over 2.15 lakh jobs in the sector.
What has happened to the automobile sector?
The industry started off 2018-19 on a good note with vehicles sales across categories growing 18% to nearly 70 lakh units in the first quarter (April-June 2018). During the quarter, passenger vehicle sales were up nearly 20%, commercial vehicles sales were up 51.55%, and that of two-wheelers grew 16%.
Why is the auto industry facing trouble?
However, domestic passenger vehicle sales declined for the first time after nine months in July 2018. In July 2017, vehicle sales spiked due to the benefits extended by the rollout of the Goods and Services Tax (GST). However, demand failed to pick up in August and September, after the floods in Kerala and heavy rainfall in several other States.
Why did inventory pile up?
In the ensuing months, consumer sentiment remained subdued as the total cost of vehicle ownership went up largely due to an increase in fuel prices, higher interest rates and a hike in vehicle insurance costs. In such an environment, the festive season too failed to boost demand, leading to a huge inventory pile-up with dealers. To add to this, the IL&FS crisis late last year led to a severe liquidity crunch, almost drying up credit for dealers and customers. Nearly half the vehicles sold in rural markets — a segment that has been witnessing a higher growth rate in comparison to urban markets are financed by non-banking financial companies (NBFCs). Being stuck with higher inventory due to a lacklustre festive season, dealers too needed more working capital.
As a result of all these factors, all vehicle categories, including commercial vehicles and two-wheelers, began experiencing negative growth beginning December setting alarm bells ringing. The industry found some solace in the fact that historically, vehicle sales decline in the months preceding elections, and expressed the hope that demand following the elections would pick up. However, this did not happen.
Are people holding off on purchases?
There is also a possibility that some customers are waiting to buy the latest Bharat Stage (BS)-VI emission standard compliant vehicles or are waiting for more incentives from vehicle makers who will be looking to sell off their BS-IV compliant stocks before the April 1, 2020 deadline. Many industry players have also expressed concern that too much focus on electric vehicles (EVs) by the government may also be encouraging buyers to postpone the purchase of petrol and diesel vehicles.
How many jobs have been lost?
The automobile sector is one of the largest employers in the country, employing about 37 million people, directly and indirectly. The prolonged demand slowdown has triggered production as well as job cuts in the sector. According to the latest figures that are available, original equipment manufacturers (OEMs) have removed about 15,000 temporary workers in the past two to three months. A lack of working capital amid tepid demand has led to the closure of nearly 300 dealerships across the country. This has led to over two lakh people losing their jobs, according to the Federation of Automobile Dealers Associations (FADA), the apex national body of automobile retail industry engaged in the sale, service and spares of two- and three-wheelers, passenger cars, utility vehicles, commercial vehicles (including buses and trucks) and tractors. Separately, the Automotive Component Manufacturers Association of India (ACMA) warned in July that 10 lakh jobs were at risk and urgent action was needed to bring the industry back on track.
Why is the current slowdown different?
Edelweiss Research has pointed out that the current slowdown in the sector is very different from the ones that the industry has gone through earlier. First, the slowdown is driven by domestic factors, including the NBFC crisis, while the earlier ones were triggered by global events. It also pointed out that over FY19-21, vehicle prices are estimated to jump 13-30% due to safety, insurance and emission-related compliance costs. For end consumers, such a steep price hike can prove a hurdle in growth recovery. Meanwhile, growing competition from the pre-owned cars market is also pulling down sales of new vehicles. For example, in the passenger vehicles segment, while the new vehicles market grew 2% in FY19, the pre-owned market saw double-digit growth.
What does the auto industry want?
The auto industry has been unable to arrest plunging sales in spite of new launches and offers and has been demanding immediate government intervention. Pointing out that the industry’s turnover is close to half of the manufacturing GDP, accounting for about 11% of the entire GST revenues of the country, the auto sector is hoping that the government will come out with a revival package ahead of the festive season to yield benefits.
The industry’s demands include a reduction in GST to 18% from the current rate of 28%, which will help in an immediate price reduction. It could kick-start demand in the short term, particularly ahead of the coming festive season. Besides, it has sought measures to handle the NBFC crisis to infuse liquidity into the system, and clarity on policy for electric vehicles and introduction of vehicle scrappage policy, which will also boost demand for new vehicles. These demands were also placed before the Finance Minister during a recent meeting.
How long will the slowdown last?
That is anyone’s guess. With BS-VI variants to be rolled out April 2020 onward, the prices of vehicles will go up. While the increase for petrol vehicles is likely to be in the range of ?20,000-?50,000, in the case of diesel vehicles it could well be between ? 1 lakh and ?1.5 lakh. The transition could also trigger some demand for BS-IV compliant vehicles in the remaining part of the year, given the price difference.