Here too, be bold

Post 370, economy will hopefully get the government’s due attention

Subir Roy
Senior economic analyst

The Indian economy is in the throes of a serious slowdown and when this kind of a situation takes a firm grip, jobs begin to disappear. What is perhaps the worst is that there is no sign of a pickup round the corner.

Both multilateral financial institutions like the IMF and the ADB, as also India’s own central bank, RBI, have been cutting their forecast of India’s growth because of rising global uncertainties and weakening domestic investment activity.

According to the Mint Macro Tracker, the slowdown stretches across both the consumer and industrial sectors. This is hurting the most in rural India where distress is being perpetuated by a fall in real rural wages for two years now.

The most visible sign of the slowdown is what is happening in the automobile sector. Passenger vehicle sales have fallen for eight straight months till June. In May it fell 20.5%, the sharpest in 18 years. Preliminary data indicates that the fall in July is higher, at 30%. Overall, the automobile sector is going through its biggest slump in nearly two decades.

Why is the automobile sector important? It is a sort of proxy for the industrial sector as a whole because of strong linkages. The automobile sector employs 35 million people directly and indirectly and accounts for 7% of India’s GDP and a whopping 49% (virtually half) of manufacturing GDP. So when the automobile sector sneezes, the economy catches a cold.

With this unprecedented decline in vehicle sales, automobile dealers have laid off 2 lakh staff during the three months to July. This will have a chain effect. With car sales declining, there will be similar negative momentum in cars coming in for servicing. This will adversely affect technical jobs. Over and above this, 32,000 jobs were lost when 286 showrooms closed down in the 18 months to April.

Why has this happened? The proximate cause is the turmoil in the financial sector. It is finance that sells cars and that finance has significantly dried up. India’s shadow banks, the NBFCs, are facing a severe liquidity crunch ever since IL&FS went belly up. When they find it difficult to refinance themselves periodically, their ability to make fresh lending goes down. NBFCs typically fund 55-60% of commercial vehicle sales, 30% of passenger car sales and nearly 65% of two-wheeler sales.

Banks proper have added to the financing drought. They have got into serious trouble with large corporate defaults, shooting NPAs and the need to make hefty provisions. The result is that banks have been reluctant to extend any kind of loan, including consumer loans. So neither banks, which lend to the best customers, nor NBFCs which lend to the rest, are financing automobile purchases the way they used to.

Now let us look at the bigger picture. For close to a decade earnings growth for the Indian corporate sector has been severely disappointing, indicating a setback in corporate profitability. The impact of this is that corporate sentiments are at a post-2008 financial crisis low. The animal spirits are as difficult to find as tigers in a few of India’s tiger reserves. Stock market indices reveal the downbeat sentiment among investors.

What has dampened business spirits is a perception that the government’s economic thinking has moved to the left. One part of this is the plethora of social sector schemes unveiled in the run-up to the elections. As resources have to come from somewhere, the Budget has got tough on the super rich.

Plus there is a feeling that the government’s thinking is also moving inward. Courtesy the prod from sections of the Sangh Parivar, trade barriers are going up. This is welcomed by sections of domestic business but dampens the mood of the most dynamic private economic decision makers. They go in for investment when they see reforms going forward, competitiveness improving and opening up to the rest of the world brightening the prospects of export-led growth.  

How do we get out of this? Eyes were turned at the monetary policy update earlier this week. A 25 basis point (100 basis points make 1%) cut in policy rates was expected but such is the depressed mood that a 50 basis points cut was being touted to shake sentiment out of its present depression. In the event, the policy rates were cut by 35 basis points.  

But there is a catch in this also. In India policy rate cuts do not get fully transmitted, the actual borrower does not see the rate he pays going down as the intermediating financial sector is in trouble and is seeking to raise its interest rate margin to earn more to provide more for past bad debts. Interest rates for car buyers have gone up even as the RBI has cut policy rates.

At this juncture the government has to come out with bold policy initiatives. It needs to have a political and economic agenda. The economic agenda delivers the actions and the political agenda the context. Unfortunately, the Union Budget turned out to be a missed opportunity in terms of coming up with a positive economic agenda. The latest developments over Kashmir indicate that the government was preoccupied with delivering its historical agenda. Now that Parliament is adjourned, the government will hopefully have the mind space for addressing urgent economic issues.

RELATED Chidambaram targets govt on economy, Kashmir