Context: Economic slowdown in India.
More in news:• India’s annual growth in gross domestic product or GDP fell to 4.5% for the quarter ended September 30, down from 5% in the previous three months.
Economic slowdown:Economic slowdown is a situation in which GDP growth slows but doesn’t decline. For example, if GDP goes from 5% growth to 3% growth, an economy is experiencing a slowdown. Most analysts do not consider a slowdown to be a recession, but unemployment may rise and productivity may decline.
Recession:Recession refers to a phase of the downturn in the economic cycle when there is a fall in the country’s Gross Domestic Product (GDP) for some quarters. It appears in the slowdown of economic activity in the economy for a few months. It may result in the fall in employment, industrial production, corporate profits, GDP, etc.
Depression:When recession turns out to be more severe and continues for a long term, in one or more economies, the situation is known as Depression. The basic rule of analyzing depression is that when there is a negative GDP of 10% of more, lasting for more than three years.Depression may result in price deflation, bankruptcies, bank failures, unemployment, financial crisis, business failures, etc. It may lead to the shutdown of the economy. The main indicators of depression are as under:• High level of unemployment.• The contraction in the economic activities.• Increase in Bankruptcies.• Decline in credit availability.• Fall in industrial production and investments.• High level of fluctuations in the value of currency, because of devaluation.
Nature of slowdowns in India:The slowdowns till the Eighties were mostly a result of drought-induced agricultural contractions, wars or balance of payments (BoP) pressures.•1961-63: Shortage of foreign exchange for imports, even of essential materials or components and spares used in capital goods, besides austerity measures introduced after the 1962 Sino-Indian War, caused the first growth dip episode.• 1965-67: Back-to-back droughts and a BoP crisis leading to the 36.5 per cent rupee devaluation of June 1966. This was primarily the cause of the slowdown during that time.•1971-73: The combination of the 1971 Indo-Pakistan War and the 1972 famine caused the growth dip in early 1970s.•1980s: Since the farm sector had a roughly one-third share in India’s GDP at point of time. The three consecutive drought years of 1985, 1986 and 1987 led to the economic slowdown.•2000-03: The growth slump of the early-2000s during the Atal Bihari Vajpayee-led National Democratic Alliance (NDA) government had mainly to do with the aftereffects of the 1997 Asian financial crisis, the sanctions imposed by the US and other countries following the 1998 Pokhran nuclear tests, and the end of a mid-1990s corporate-driven mini-investment boom.•2012-14: The last two years of the United Progressive Alliance (UPA) regime were preceded by “twin deficits” — on the fiscal and external current account fronts.
|Twin Deficit: Current Account Deficit and Fiscal Deficit (also known as “budget deficit” is a situation when a nation’s expenditure exceeds its revenues) are together known as twin deficits and both often reinforce each other, i.e., a high fiscal deficit leads to higher CAD and vice versa.|
•2018-19: Unlike all the earlier downturns whose triggers were supply-side constraints in food and forex, macroeconomic imprudence or external shocks, what we are now experiencing is more of a “western-style” slowdown exacerbated by internal policy misadventures. At the heart of it has been the twin balance sheet (TBS) problem.
|Twin Balance Sheet Problem: A balance sheet is a financial statement that summarizes a company/institution’s assets, liabilities and shareholder’s equity at a specific point of a time. Twin Balance Sheet Problem (TBS) deals with two balance sheet problems. It refers to the ballooning of debt on the books of corporate entities and the estimated Rs10 trillion of stressed assets that have piled up at banks because of the inability of borrowers to repay. Thus, TBS is two two-fold problems for the Indian economy which deals with: 1. Overleveraged companies – Debt accumulation on companies is very high and thus they are unable to pay interest payments on loans. Note: 40% of corporate debt is owed by companies who are not earning enough to pay back their interest payments. In technical terms, this means that they have an interest coverage ratio less than 1. 2. Bad-loan-encumbered-banks – Non Performing Assets (NPA) of the banks is 9% for the total banking system of India. It is as high as 12.1% for Public Sector Banks. As companies fail to pay back principal or interest, banks are also in trouble.|
Reasons for economic slowdown:• Jolt of reforms: demonetisation happened in November 2016, dealing a severe blow to consumption, leading to a vicious cycle of job loss and lower income, which led to further drop in demand.•Goods and Service Tax (GST) introduction: next shock came in the form of a reform-when GST was rolled out in July 2017. This had a knock-on effect on exports growth in the year of implementation because of delay in refunds to exporters• Tight fiscal and monetary policies: the combined fiscal deficit of the centre and states is very high. And the government committed to lowering its fiscal deficit, it left little room for government to increase its spending to pump up the economy. And monetary policy was focussed on inflation control, which ensured interest rates remained hard.• Bank NPAs: most Public Sector Banks are saddled with high Non Performing Assets that have resulted in them tightening lending and instead, seeking deposits and otherwise repairing their balance sheets by making provisions for Bad Loans.• Global slowdown: the most important factor is that there is also a global economic slowdown that is happening and given the fact that India is a net commodity exporter, there has been a slump in the volumes of exports. With the US-China trade war, global sentiments have remained poor, making the prospects of an export led growth bleak. Add to that, a looming Brexit.• Farming crisis: Non-food inflation continued to surpass food inflation in the past two years, amounting to income transfers from rural to urban areas.•Savings and Investment: The domestic saving rate has declined from 31.4% in 2013-14 to 29.6% in 2016-17.The gross capital formation rate has declined from 33.8% to 30.6% during same period. For any country’s growth consistent rise in savings and investment should be needed.•Retreat of globalization: Apart from that, the global slowdown has also been accompanied by a retreat of globalization which has resulted in FDI or Foreign Direct Investment being only in the areas of speculative finance and distressed assets purchases rather than into investments that help the Real Economy.• Structural transformation: the slowdown is also part of a longer-term structural shift wherein the Economy is shifting gears from the high investment era to a low investment era as well as a transition from being cash-driven economy to a digitally enabled economy.
Measures taken by the government to improve the slowdown:•Tax Incentives: The Central Board of Direct Taxes (the CBDT) has provided in a recently issued notification, that an investment fund set up by a Category-I or Category-II Foreign Portfolio Investor (FPI) registered with the Securities and Exchange Board of India (the SEBI) need not satisfy the investor diversification conditions stated in the ITL to qualify as an EIF.• Additionally, the CBDT has specified the list of countries in which the investment fund should be established, incorporated or registered to be eligible for benefits under the safe harbor regime.• Recapitalization: The government on Friday announced a fresh capital infusion of about $10 billion (Rs. 70,000crore) into debt-burdened state banks and credit guarantees to support shadow lenders in a bid to boost lending and revive the economy.• SME payments: SME payments are to be streamlined with a one-time settlement plan in place and the government is to ensure that it makes its payments on time for projects (over Rs 40,000crore is stuck in the pipeline).• Sectoral measures: The auto sector is to get some relief on depreciation on vehicles and the government has clarified on the validity of registration on Bharat IV vehicles, the government will now be buying new vehicles, which was barred earlier. The Union Cabinet has cleared a proposal to set up a ‘Special Window’ in the form of Alternative Investment Fund (AIF) to provide priority debt financing for the completion of stalled housing projects that are in the affordable and middle-income housing sector. The corpus size of the AIF would be scaled up to Rs 25,000 crore after SBI and LIC pump in funds.• FDI measures: The FDI rules now give single brand more breathing space in terms of local procurement and setting up of physical structures. Also, 100 per cent FDI through the automatic route in coal mining and related activities has been permitted.• As has 26 per cent FDI under the government route for uploading/ streaming of news and current affairs in digital media. However, these rules take time to work out and one does not expect to see a flurry of capital flows.• Mergers: in the biggest consolidation exercise in the banking space, the government announced four major mergers of public sector banks, bringing down their total number from 27 to 12, a move aimed at making state-owned lenders global sized banks• The merger of PSBs will unlock new potential. Big banks with their national presence and global reach will have larger credit appetite and ability to measure risk.
Measures to overcome the slowdown:• Investment: Investment levels are influenced by many factors such as investor confidence, bank lending, and infrastructural constraints, but interest rates are by far the most important factor for they determine the profitability of investment. So recently RBI reduced the interest rates in right direction• Rupee exchange rate: The exchange rate is a crucial price that determines the amount of rupees earned per dollar of exports and exercises an important influence on the profitability of exporting firms Between January 2014 and June 2017, the rupee appreciated by 10% in nominal terms and 15% in real terms (adjusted for inflation).• The poor export performance in this period is no surprise. So government should work bilaterally and control the appreciation of rupee• Counter-cyclical policies: If there is a slowdown or downturn in an economy, governments should use counter-cyclical, expansionary, macroeconomic policies to revive growth.• Fiscal policy should provide a stimulus, preferably by stepping up public investment. Monetary policy should provide a stimulus to private investment by lowering interest rates.• Sustainable investment: Government borrowing is always sustainable if it is used to finance investment and if the rate of return on such investment is greater than the interest rate payable. So government should promote PPP model investment• Fiscal space: Allow the fiscal deficit to rise by 0.5% of GDP, using that to finance public investment, and to drop interest rates in steps by at least 2 percentage points, which would also help the exchange rate depreciate. Together, these would stimulate investment and promote exports, to revive economic growth.