The growth collapse

Global factors do not fully explain the slowdown

There was a near consensus on the direction, but the magnitude of the deceleration in growth surprised most analysts. The Indian economy in the first quarter of the current fiscal year grew at 5 per cent, compared to 5.8 per cent in the previous quarter and 8 per cent in the same quarter last year. While growth in the manufacturing sector slowed to a dismal 0.6 per cent, expansion in agriculture slipped to 2 per cent, compared to 5.1 per cent last year.

The latest data should worry Indian policymakers because it is now absolutely clear that problems in the economy are much deeper than they were willing to accept. Nominal growth during the quarter collapsed to a 17-year low of 8 per cent. This will not only affect revenues for the corporate sector and their ability to repay debt but will also put government finances in serious trouble. The Union Budget has assumed a nominal growth rate of 11 per cent.

Growth has slowed due to a variety of reasons. For instance, as the government has also argued, the global economy is slowing and uncertainty has risen because of US-China trade tensions. However, this is a specious argument because global factors do not fully explain the extent of the slowdown and should not be used to cover India's internal weakness. For example, China, which is at the centre of the ongoing trade war with the US, grew at 6.2 per cent in the June quarter. It is difficult to argue that India is getting affected by the trade war more than China. Further, Vietnam clocked a 10-year-high growth rate of 7.1 per cent in 2018, according to the International Monetary Fund. Reports suggest that it is now facing a shortage of labour. Businesses moving out of China are looking to set up plants in Vietnam. Similarly, Bangladesh, after growing at about 8 per cent in FY18, is expected to grow at well above 7 per cent. Moreover, global financial conditions are benign and crude oil prices are within India's comfort zone.

However, the high-frequency data suggests that a rebound is not imminent. The government's reluctance to accept the problem has also worsened the situation. In fact, instead of improving the ease of doing business, the July Budget ended up dampening business and investor confidence. To be sure, the government has taken some positive decisions in recent weeks, but it would not be enough to revive economic activity to the level desired. So, there will now be a clamour for fiscal stimulus. Clearly, the government does not have the room to increase expenditure. On the contrary, the slowdown will itself put enormous pressure on government finances. Since inflation is expected to remain low, there is scope for monetary accommodation. But transmission has been an issue, and monetary action in India works with a lag of two to three quarters.

Policymakers would be well advised to not solely depend on monetary policy for revival. The nature of the slowdown suggests that problems are not cyclical alone. Granted that growth will stabilise once issues in the financial sector are addressed. But this would not be enough. India needs wider structural reforms in practically every aspect of doing business to compete in a rapidly changing global environment. In the absence of structural reforms, as the history shows, India will only see bouts of relatively high growth, but will not be able to sustain it.