Economic Slowdown: Analysis

Relevance: Mains: G.S paper III: Indian Economy

Context

• The growth rate of real gross domestic product (GDP) has dipped to 5% in the first quarter (Q1) of the current financial year, the lowest recorded in recent years.
• Both consumption and investment demands have contributed to this depressed economic situation.

Analysis of Economic slowdown

• Most of the producing sectors, such as agriculture, mining, and quarrying, and manufacturing have witnessed a serious setback in growth during Q1 of 2019–20.
• Of this, the most worrisome has been the manufacturing sector, the gross value added (GVA) of which edged up by just 0.6% compared to a growth of 12.1% during the same period last year.
• The private final consumption expenditure (PFCE) grew at 3.1% during Q1 of the current year compared to 7.3% a year ago.
• The widespread slackening of growth across major industries has had deleterious effects on the economy’s performance, and this is likely to linger on in the medium-term as well.
• The rate of the economic slowdown can be understood from the employment rate and sluggish tax collection rate compared to previous years.

Effect on employment

• The economic slowdown is reflected in the results of the Periodic Labour Force Survey of 2017–18.
• 8% of males in rural areas and 7.1% males in urban areas, and 3.8% of females in rural and 10.8% in ­urban areas reportedly remaining unemployed.
• This is the highest ever reported unemployment rates over 45 years.
• The employment crisis has led to demand crisis especially in the rural areas, this has affected the activities of the major manufacturing sectors.
• Major auto companies have increased “non-working” days, that is, holiday without pay, at their production plants and reduced subcontracting activities.
• If this is the kind of infliction faced by the formal sector, it leaves one to wonder how the story is unfolding in the informal segments.

Effect on tax collection

• The intensity of growth traction is also evident from the sluggish advance tax collection.
• The recently released data shows that advance tax during the current financial year till mid-September grew at a rate of 6%, significantly deviating from its record of 18% in the same period a year ago.
• As these taxes are collected as and when income is earned, this shows that income generation in the formal sector is badly affected. It, thus, appears that the second quarter would not be any better.

Factors affecting the growth rate

• The slowdown in the economy is has been visible since the demonetisation in November 2016 and improperly implemented Goods and Services Tax (GST).
• This trend is likely to be aggravated if the pressure on international oil price increases due to the unrest in West Asia following the drone strikes on Aramco, the largest refinery facility in Saudi Arabia.
• Another issue of great concern is the cascading effects on other sectors when the manufacturing sector is affected.

Steps taken by RBI and the government to revive the economy

• The Reserve Bank of India (RBI) has been consistently reducing the repo rate.
• Repo rate – Rate of interest at which the central bank (Reserve Bank) lends money to the commercial banks when there is a shortage of funds.
• The repo rates are reduced with the hope that banks would pass on the benefits to customers, and thereby spike off credit demand by both industrialists for investment and consumers for consumption.
• In order to ensure the benefits are passed on to consumers, RBI has suggested to banks to link their lending rates to the repo rate.
• One of the major challenges faced by the banking industry is the reduction in deposit growth due to competitive claims by other savings instruments.
• Other steps taken are as follows:

• • Amalgamation of 10 banks with recapitalisation to the tune of ₹70,000 crore
  • Rollback on the surcharge on tax on foreign portfolio investors
  • Specific measures concerning automobiles, housing and export sectors.
  • Loan melas in 400 districts
  • Slashing of basic corporate tax rates to 22% from 30%, though many more are still expected.

The outcome of the steps taken by the government

• Consecutive cuts in the repo rates

• • This step will work to lower the lending rates of banks only if there will be a pick-up of credit demand from the public.
  • Growth of credit supply is determined by credit demand and not the other way round.
  • Reducing the repo rates may pave way for additional borrowings at the lower rates to finance speculation in financial markets, which will not help revival of the real economy.
• Reduction of corporate tax:
  • The proposed tax benefits for the super-rich will further widen the inequalities within the country, and little of the tax-exempted income will be channelled beyond the speculative zone of stock markets and real estates.
  • Additions to savings, if achieved, again, will not generate real investments unless demand for investment is forthcoming in the market.
• Tax relief to portfolio investors
  • This step is potentially effective in temporarily stimulating the secondary stock market.
  • But these may not work to reverse the tendencies for the stagnation even in the financial sector, let alone in the overall real economy.
  • A revival of the stagnating real economy demands additional investments in physical terms with related expansions in jobs.
  • Little of those are likely to be fulfilled by a boom in the secondary market of stocks and the related gains on speculative and short-term investments.

Conclusion

• Steps taken by RBI and government are micro attempts to revive the economy.
• More important is the need for radical change in macroeconomic policies—both monetary and fiscal—in favour of providing ­expansionary impulses.
• Expansionary fiscal policies to provide impetus to both consumption and investment, particularly in the rural sector, are the need of the hour.
• There is an urgent need for public expenditure as investments, as well as for social sector expenses, the government abides by its self-imposed limits of the fiscal deficit to GDP ratio, which restrains additional public expenditure.
• The dictum is provided by the Fiscal Responsibility and Budget Management Act (FRBMA) of 2003.
• It needs to be recognised that official expenditure remains a prerequisite to stimulation of private spending, especially in the current context of a demand deficient domestic economy.
• Considering the gravity of the situation, this is the moment for a call to the state to “act” and not just “protect” the interests of stock market speculators, the disgruntled super-rich or bankers.
• With the possibility of augmenting tax revenue fading, the stepping up of public expenditure to revive the economy becomes a major challenging task, but this would require a fresh look at the policy of fiscal consolidation.