A Word on India’s Economic Slowdown
India has faced its slowest growth in recent times in the April to June quarter of the current financial year. Growth has slumped to 5.7 percent in the 1st quarter of 2017-18 which is a 0.4 percent decline from the 4th quarter figures of 2016-17. The jury appears to be relatively undecided on what has caused this decline. Broadly speaking, there seem to be two camps which have significantly different ideas on what has caused this. The first camp states that this slowdown is due two very disruptive decisions of the Indian government. These decisions include the rollout of a new Goods and Services tax (GST), which replaces the earlier and more inefficient indirect tax policy and the Demonetisation of high-value currency in November 2016 which sought to end tax evasion by people who stashed their incomes in cash. The other camp contends that the trend of low growth highlights deeper cracks in the structure of the economy as indicated by declining Private Investment and other factors.
It is quite true that Demonetisation and the rollout of the GST have had an adverse impact on the economy. I have pointed out in an article that, as a consequence of Demonetisation, the real GDP growth in the Jan- March quarter of 2016-17 declined to 6.1 percent, which made it the lowest growth figure in two years. The real GVA (Gross Value Added at 2011-12 prices) in Q4 of FY’17 for Construction, a sector heavily reliant on hard cash for production activities, saw a contraction of 3.2 percent from the previous quarter. Clearly, Demonetisation led to an economic disruption, a decline in production and a reduction in consumer demand due to constriction of cash.
As far as GST is concerned, the data from the April-June quarter of 2017-18 tells a worrying story. As stated in the beginning, the economy has grown at 5.7% annually in the April-June quarter, its lowest level in more than three years and well below expectations.The GDP growth in the same quarter last year was 7.9% and this current growth figure is undeniably dismal in that context. The introduction of the Goods and Services tax is one the chief contributors to this low figure. The Hindu notes that “[b]usinesses nationwide whittled down production in the April-June quarter and focused on off-loading the existing stock, thanks to the uncertainty about how the new indirect tax regime will treat earlier tax credits on inputs.” Apart from this uncertainty, the new tax system has many compliance issues, for instance, traders have to file returns thrice every month using a malfunctioning digital platform. These compliance issues have punished both large and small businesses.
At this point, it would seem that Demonetisation and the GST are the real reasons behind India's economic woes. However, the impact of Demonetisation and the Goods and Services tax is temporary and it can be overcome by active steps taken by the government. In fact, the Indian Government is already taking correction measures. It has announced an INR 6.92 trillion mega road building project to jump-start the economy and a tax cut on petrol/diesel prices that will reduce production costs. The government has also eased some of the compliance issues surrounding GST for small businesses and has reduced many of the high rates on certain goods that punished industries.
Both Demonetisation and GST have caused substantial disruption but not real problems that could completely stifle economic growth. It would be wrong to state that economic issues that have a temporary impact and relatively quick solutions are the real cause of the current economic downturn, especially when they have done some good. Demonetisation has arguably led to the identification of 37,000 shell companies; and a streamlined, simplified and well-implemented GST would greatly help the economy. It seems rather inaccurate to say that decisions like Demonetisation and GST with their temporary upheaval have single-handedly brought growth down sharply in the past two quarters.
The strength of this point is bolstered by the trend of low growth visible in the last five quarters. According to The Hindu, “[t]he growth recorded in the [earlier four] quarters was 7.9 percent, 7.5 percent, 7 percent and 6.1 percent. So this is the fifth quarter in a row that the growth has slipped, with the pace of decline picking up momentum in the last two quarters.” This clearly shows that these measures of the government have only exacerbated an already existing problem. GST and Demonetisation may have caused disruption but they did so in an already weakened economy. Demonetisation and GST are only bad speed bumps in already bad road.
So, the question that arises then is what is slowing down the Indian economy? The answer, in my opinion, lies in the argument of the second camp. India’s economy has structural issues. The credit-creating sector of the economy- the banking sector has a 'bad loan’ problem.
According to most recent data, Indian Banks had a record 9.5 trillion rupees ($145.56 billion) of non-performing assets at the end of June. In fact, “total stressed loans - including non-performing and restructured or rolled over loans - rose 4.5 percent in the six months to end-June. In the previous six months they had risen 5.8 percent.” Stressed loans as a percentage of total loans have reached a high 12.6 percent.
The consequence of this bad loan problem is that it has stifled lending and credit creation. Banks when faced with unpaid debt are forced to make provisions for money lost and are thus prevented from lending readily. Banks in this situation become risk-averse and do not provide credit to industry, investing instead in other risk-free assets such as government bonds. The Economic Times reports that new loans grew at a measly 5 percent in the year to March. While government bond yields comprised “22.7 percent of banks' operating profits in the last financial year, doubling its share from a year earlier.”
The impact of this low growth in lending is declining Private Investment. With Banks forced to abstain from lending, industry is unable to raise money needed for investment which leads to lower growth. The Gross Fixed Capital Formation (GFCF) figures, which measure investment, reflect this reality. The share of GFCF in the GDP fell to 25.5 percent in Q4 of 2016-17 compared to a 28.5 percent share in the same quarter a year ago. Indeed, GFCF has risen marginally well by 1.6 percent to 29.2 percent of the GDP in Q1 of this fiscal. But there is a clear sign visible from the last fiscal, when GFCF growth was a mere 2.4 percent- a fall from 6.5 percent last year, to indicate that the under-performing banks have led to abated investment activity.
The government has taken some prudent steps in solving this crisis but it has omitted. It has begun implementation of the Insolvency and Bankruptcy Code, 2016 to facilitate time-bound and certain procedures for bankruptcy and insolvency situations. The government has also announced a $32 billion bank recapitalization plan for public sector banks which have the largest market share and the most stressed assets. However, this recapitalization plan or Bankruptcy code does not address the root of the problem: mismanagement of public sector banks.
Public sector banks in India are grossly mismanaged. For example, The State Bank of India (SBI), the largest bank in India and a public sector bank, fares poorly in complying with corporate governance norms. In fact, SBI has no independent directors to help detect fraud and provide independent guidance on the banks’ functioning. All listed companies like the SBI are mandated to have independent directors comprising 50 percent of their Board. Independent directors are distant from management and act as the trustees of shareholders. Their absence and other evidence of malgovernance in many other public sector banks clearly shows how the real problem with banks is in their management. The Indian government has done little to address this mismanagement issue. It has instead pushed small, ailing public banks to merge with the SBI in the recent past, pooling more stressed assets for the already ailing SBI and subjecting the SBI to the complexities of mergers and the responsibility of reviving banks that are worse off.
The Indian economy's real handicap is due to the problems associated with the banking sector that harbingers growth through credit. GST and Demonetisation have only caused but an increase in the woes of an economy which already had notable structural issues. The Indian government has failed to address the bad loan issue for a long time and it's recent decisions in that regard ignore key aspects of the problem. I hope that the government will tackle this issue whilst eliminating the problems associated with the GST, thus undertaking a comprehensive and expansive programme to revitalize and strengthen the Indian economy.
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