WHAT AILS THE INDIAN ECONOMY (PART 1)
The Indian Economy has gone through one of the toughest periods since the beginning of the Millennium over the last three years. With the ushering in of the new government there has been a rejuvenation of hope which is reflected in Consumer and Corporate confidence. However this has not translated into actual economic activity till date. This is somewhat strange in the context of the fact that normally strong consumer confidence does translate into higher consumption spending. However this has not happened till now. Investment activity also continues to be on the slow lane as the NDA government grapples with trying to fix the system for smoother execution of projects. Let’s look at some aspects of the economy now
Poor Consumption – Consumption held on quite well even during the time when the economy was in absolute doldrums. However despite a strong recovery in consumer sentiment there has been no pick up in consumption. A large number of companies actually believe that consumption of their products is worse than last year. So what explains this? In my view there are 3 major factors
–High inflation of the past- Indian’s have had to go through a phase of unprecedented inflation over the last 3-4 years. Even though we can be happy at seeing a figure of 5.52% for the CPI as the latest print the fact of the matter is that CPI has gone up in absolute terms by nearly 40% since the beginning of 2011. Most people have had to reduce savings and cut corners in order to keep up with their lifestyles. The inflation has been worse for the Lower and Middle class owning to the fact that Food Inflation in the same time period has been greater than the overall CPI by 5-10%. This has also happened at a time when economic activity has been slow and as such the increase in incomes has been muted across the board. In such a situation it is very difficult for people to suddenly start spending more even though they might be feeling better. On the one hand their overall savings have reduced which need to be built up and on the other hand a better sentiment has not yet translated into better incomes for people at large. Inflation on the services side of the economy has also been very high. As such lower inflation in the near term will go more into saving than spending.
–Falling rural incomes- The rural consumption story has been strong over the last few years as the multiple impact of MNERGA and huge increase in Minimum Support Prices for various agricultural products led to strong rural incomes. Incomes were also supported by high prices of various agricultural cash crops like Sugarcane, Rubber etc. As such, although rural inflation was also high it was counterbalance by high rural incomes. However this does not hold any longer. Spending under various rural employment schemes has been curtailed now. Moreover agricultural commodity prices have come down substantially from the highs of 2013 and on top of that MSP increases have been muted this year. Agricultural production is also down due to the erratic monsoons. Under the circumstances rural consumption is coming under pressure.
–Inflationary expectations are still high- Normally after a period of very high inflation there is a general belief that inflation will remain high for a prolonged period of time. The same is the case in the inverse. As such, although prices might be coming down the expectations in the minds of people still continue to be high and this makes them save more than spend. Although people do see a brighter future they would rather wait for it to come rather than spend in its expectation.
Poor Investment Cycle- In a recent survey of corporate it was revealed that nearly 54% of companies are still operating at a capacity utilization that is below 75%. More than 20% operate below 50%. Only a single digit of companies is operating near a figure that exceeds 90%. Now this creates a situation where even after the economy starts showing some traction and growth picks up there is unlikely to be a huge Corporate Investment boom in the near term. Any large corporate capital expenditure cycle will take at least 2 years to kick in. In this situation the key is to see what will lead to an industrial revival.
–Misplaced focus on Fiscal Deficit- As the demand revival kicks in we will start seeing better figures on the IIP, however this will be in the absence of any huge corporate capital expenditure. 6-12 months from now the companies will start planning expansions and the real impact of this pending will be seen 1-18 months down the line. Under the circumstances the government needs to step in to revive demand. However the Finance Ministry in continuation of the UPA tradition is focussed on an artificial fix of the Fiscal Deficit. A reduction in Fiscal Deficit by reducing economic growth is a vicious cycle which is difficult to come out of. The Finance Ministry needs to stop pleasing rating agencies and foreign brokerage economists and get back to getting the economy on track. They also need to come out with realistic estimates of numbers. For example figures that came out this week show an amazing divergence between reality and what has been projected just three months back. Indirect tax increase for the first seven months has been just 5.6% against a projected 25.8% leaving a huge gap of Rs 50,000 Cr in government finances. If crude oil prices had not fallen the Fiscal Deficit would have easily crossed 5% this year.
Growth and only growth is the fix to India’s Fiscal Deficit problem in the long run.