Event

India is experiencing its worst economic slump since 2002. The latest quarterly GDP growth data confirmed that the economy stubbornly continued to decelerate (to an annual 4.5% between July and September 2019) for the sixth consecutive quarter since Q2 2018. Based on the IMF’s latest forecast of 4.8% for the current financial year (FY) 2019 (ending in March), the country might record its lowest growth rate since 2002.

To stop the bleeding and revive the economy, the Indian authorities have implemented and announced several stimuli. The Reserve Bank of India has cut the interest rates several times since last year (to currently 5.15%) and it has recently taken extra measures to boost bank lending. Moreover, the government’s last budget (2020-2021) contains a few proposals to support investment and consumer demand. After the corporate tax rate had been cut from 30% to 22% last September, the crucial agriculture sector and – to a lower extent – transport (notably highways) have been allocated higher spending. However, the general perception is that the government’s measures are timid and probably insufficient to bolster a flagging economy.

Impact

India’s economic downturn is broad-based and explained by many factors. The manufacturing industry is in a negative cycle, highlighted by the car industry gloom (40% of the manufacturing sector), whereas the important services sector has weakened. The fall in consumption, in a country first driven by its broad domestic market (consumption accounts for nearly 60% of GDP), is partly explaining the ongoing negative momentum. Consumer demand has fallen in the countryside – hit by increased poverty and volatile agriculture output (given erratic monsoons) – and the situation on the labour market is poor. Large job losses have been recorded in various sectors such as the car sector, and the unemployment rate is at 6%, a 45-year high.

More generally, structural weaknesses and depressed consumer and business confidence probably best explain the magnitude of the downward growth trajectory. Indeed, the Indian economy continues to be harmed by weak state banks and insufficient public and private investments. The banking sector, partially recapitalised under Modi’s rule, remains vulnerable – with heavy non-performing loans – and fragile after having suffered from various scandals. Shadow banks are not in better shape either as several significant debt defaults surfaced since summer 2018, which led to a funding squeeze by formal banks. Therefore, overall credit growth has fallen again to lower levels (close to 7%) which hinders economic recovery prospects. This explains the government emphasis on boosting lending as banks have understandably become more cautious. However, the problem is not only at a supply level with companies, many of which highly indebted, not very keen on investing in the gloomy economic climate. Hence, it will take some time for the confidence to return.

With a deep general government fiscal deficit (expected at 7.4% of GDP in FY 2019) and high public debt (69.8% of GDP expected in FY 2019), Modi’s government has limited fiscal space to address the economic slowdown. The situation is nevertheless worrying enough to delay fiscal consolidation, as PM Modi is aware that disappointing socioeconomic performances remain the Achilles heel of his government so far. Still, even though bolstering the economy is a priority, maintaining budgetary discipline is also one of his recurrent commitments and helps to understand the absence of bold short-term measures notably in favour of the rural poor to raise domestic consumption. The government also announced further trade restrictions, by raising duties on a range of imports, aimed to support the local manufacturing sector and revive the ‘Make in India’ project with the hope to deliver more jobs and lift consumption.
As the economy is probably bottoming out and various supportive public measures should eventually stimulate the economy, GDP growth is expected to rebound during the year but at gradual pace, i.e. towards 5.8% for FY 2020-2021.

The economy is not alone in experiencing a hard time. The security climate has been deteriorating under PM Modi’s pro-Hindu policies as instability risks have further increased since he was re-elected last spring. Two measures particularly have fuelled controversy and unrest: last August’s abrogation of the Jammu-Kashmir special constitutional status (now divided into two union territories under New Delhi’s control) and the Citizenship Amendment Act that makes the access to citizenship easier for all illegal non-Muslim migrants. Protests have spread across the country especially among the Muslim community which is feeling increasingly discriminated. Externally, the conflict risk with Pakistan was exacerbated by the decision on Kashmir with a rising risk of terrorist attacks and military tensions in the area, potentially spilling over to some extent to the rest of India. The coming months will tell whether PM Modi will (temporarily) soften his position in the face of the size of protests and rising violence, and also considering his BJP partys recent defeat at the New Delhi elections. For sure, protests and ethnic tensions will do nothing to revive confidence and to support the launch of unpopular structural reforms.

Analyst: Raphaël Cecchi – r.cecchi@credenddo.com