Cyclical or structural? Decoding the nature of India's economic slowdown

A slowdown in consumption demand, decline in manufacturing, inability of the IBC to resolve cases in a time-bound manner and rising global trade tension is impacting India, analysts say

India’s real or inflation-adjusted gross domestic product (GDP) grew at 5 per cent in the June 2019 quarter of financial year 2019-20 (Q1FY20), the slowest growth in six years (25 quarters). In nominal terms, the growth stood at 7.99 per cent, lowest since December 2002.

With this, fears of the slowdown being a more structural one than a cyclical one have surfaced.

What is a cyclical slowdown?

A cyclical slowdown is a period of lean economic activity that occurs at regular intervals. Such slowdowns last over the short-to-medium term, and are based on the changes in the business cycle.

Generally, interim fiscal and monetary measures, temporary recapitalisation of credit markets, and need-based regulatory changes are required to revive the economy.

What is a structural slowdown?

A structural slowdown, on the other hand, is a more deep-rooted phenomenon that occurs due to a one-off shift from an existing paradigm. The changes, which last over a long-term, are driven by disruptive technologies, changing demographics, and/or change in consumer behaviour.

Dissecting India’s slowdown

A slowdown in consumption demand, decline in manufacturing, inability of the Insolvency and Bankruptcy Code (IBC) to resolve cases in a time-bound manner, and rising global trade tension and its adverse impact on exports are some of the factors affecting India’s growth, analysts say.

Consumption:

“Private consumption, which contributes nearly 55-60 per cent, to India’s GDP has been slowing down. While the reduced income growth of households has reduced urban consumption, drought/near-drought conditions in three of the past five years coupled with collapse of food prices has taken a heavy toll on rural consumption,” said analysts at India Ratings and Research, Indian arm for Fitch Group. The private final consumption expenditure (PFCE) has slumped to 3.1 per cent in Q1FY20, the weakest level since Q3FY15.

A slowdown in the GDP growth for the fourth consecutive year, from 8.2 per cent in FY17 to around 6.5 per cent in FY20 (E), makes it a case of structural slowdown, they say.

“The increase in change in stock (in current prices) from Rs 34,485 crore in Q1FY17 to Rs 47,805 in Q1FY20 also indicates inventory build-up and hence reflects consumption slowdown,” Soumya Kanti Ghosh, chief economist at State Bank of India, wrote in his weekly note, Ecowrap.

Ghosh further attributes the slowdown in the consumption sector to change in the consumption pattern.

“Inclination towards Herbal and Ayurveda oriented personal care products, presently being made in the unorganised segments, which are not formally captured by the data, could be one of the reasons for a downward bias in the data,” he wrote in his note.

Savings:

Savings by household sector – which are used to extend loans for investment -- have gone down from 35 per cent (FY12) to 17.2 per cent (FY18). Households, including MSMEs, make 23.6 per cent of the total savings in the GDP.

“Since households are the only net savers in the economy, their savings are major contributors towards investment. These savings have now reached to a level which isn’t adequate to fund the government borrowings… This will keep interest rates elevated,” says Sunil Kumar Sinha, principal economist, India-Ra.

Investment:

Gross Fixed Capital Formation (GFCF), a metric to gauge investment in the economy, too has declined from 34.3 per cent in 2011 to 28.8 per cent in 2018, government data show. Similarly, in the private sector, it has declined from 26.9 per cent in 2011 to 21.4 per cent in 2018.

The household sector, which is the biggest contributor to the total capex in the economy, invests nearly 77 per cent in the real estate sector, which has lost steam since demonetization.

The way out?

Analysts say under the current macro environment, monetary policy seems to be less effective than fiscal policy as ‘improper transmission mechanism’ fails to pass on benefits to the real economy.

The Reserve Bank of India (RBI) highlighted a broad-based cyclical downturn in several sectors, including manufacturing, trade, hotels, transport, communication and broadcasting, construction, and agriculture, and called for counter-cyclical actions in terms of monetary and fiscal policies, along with deep-seated reforms for the structural slowdown.

Further rate cuts, increase in fiscal spending, deviation from fiscal deficit target, and boost in consumption sentiment are some of the suggestions by analysts to arrest the downtrend. On its part, the RBI has cut the repo rate by 110 basis points so far in CY19 to 5.4 per cent – its lowest level since 2010.

“There are structural issues in land, labour, agricultural marketing and the likes, which need to be addressed,” the central bank said in its Annual Report for 2018-19.