New Delhi: The gross domestic product (GDP) growth figure is not just a number. For millions of Indians, it creates the hope of putting shoes on their children’s feet, repairing a leaky roof, or having the money to ferry a patient to the nearest hospital. The liberalization of 1991 created economic growth that lifted huge swathes of our population above the poverty line. By one widely accepted metric, 2% of Indians were eased out of absolute poverty every year since. Sustained growth and the expansion of welfare programmes, many felt, would take care of the rest.

The recent quarterly growth numbers, and the Reserve Bank of India’s (RBI’s) projection of a fall in growth for the current year, provide a harsh reality check. In the April-June quarter, India’s GDP grew by only 5% over the same quarter of 2018, way below the consensus of 5.7%. Private consumption, the money our citizens spend on themselves, inched up by 3.1%. Meanwhile, population grew as well, by a little under 2%. This means that, over the last year, the average per capita consumption of the Indian citizen grew by just over 1%.

This is a tragic fact for the average Indian citizen. We are back to the “Hindu rate of growth", when the average citizen would have to wait 70 years to see her standard of living double—if she lived that long. Post 1991, for a quarter of a century, the average Indian was doubling her standard of living every 12 years. This reality spawned hope and ambition in our towns and villages, and exuberance among our entrepreneurs and politicians. When the National Democratic Alliance government first came to power in 2014, the promise of 10% GDP growth seemed ambitious, but not totally far-fetched.

View Full Image SIP flows have largely held steady despite erratic market movements.

New Delhi: The gross domestic product (GDP) growth figure is not just a number. For millions of Indians, it creates the hope of putting shoes on their children’s feet, repairing a leaky roof, or having the money to ferry a patient to the nearest hospital. The liberalization of 1991 created economic growth that lifted huge swathes of our population above the poverty line. By one widely accepted metric, 2% of Indians were eased out of absolute poverty every year since. Sustained growth and the expansion of welfare programmes, many felt, would take care of the rest.

The recent quarterly growth numbers, and the Reserve Bank of India’s (RBI’s) projection of a fall in growth for the current year, provide a harsh reality check. In the April-June quarter, India’s GDP grew by only 5% over the same quarter of 2018, way below the consensus of 5.7%. Private consumption, the money our citizens spend on themselves, inched up by 3.1%. Meanwhile, population grew as well, by a little under 2%. This means that, over the last year, the average per capita consumption of the Indian citizen grew by just over 1%.

This is a tragic fact for the average Indian citizen. We are back to the “Hindu rate of growth", when the average citizen would have to wait 70 years to see her standard of living double—if she lived that long. Post 1991, for a quarter of a century, the average Indian was doubling her standard of living every 12 years. This reality spawned hope and ambition in our towns and villages, and exuberance among our entrepreneurs and politicians. When the National Democratic Alliance government first came to power in 2014, the promise of 10% GDP growth seemed ambitious, but not totally far-fetched.

Today, Google searches for “Indian economic slowdown" are spiking; the International Monetary Fund says that the Indian economic growth is much weaker than expected; and while the decline in automobiles can be attributed to the adoption of Uber and Ola by millennials, I haven’t yet heard a lifestyle justification for a sharp drop in sales of underwear.

Three questions arise at this juncture: What happened to the growth story? How will the slowdown pan out? And what should the individual investor do?

The roots of distress

The 2008 financial crisis threatened to derail growth in the Indian economy. Credit markets were rocked, and lenders froze in fright. Indian government bonds signalled the distress and the 10-year bond yield soared from 6.5% in January 2008 to 9.5% by July. Western governments rushed in to rescue their financial institutions, while their central bankers flooded financial markets with liquidity. Indian interest rates were cut in response, and by the end of the year, our bond yields were at all-time lows of 4.5%. The crisis passed, and after a sharp drop in 2008, our economy grew by 7.9% in fiscal 2008-09, and by 8.5% in 2009-10. Between March 2009 and October 2010, bank stocks, as measured by the Bank Nifty, soared almost fourfold. But under the hood of a soaring Nifty, there was trouble brewing in the engine of the economy. With the benefit of hindsight, we can see several key structural tensions building up.

Firstly, GDP growth had turned jobless. Between 1972 and 2004, every 1% of GDP growth led to a 0.5% growth in employment. Thereafter, the ratio dropped to 0.1%, and never recovered. The Mahatma Gandhi National Rural Employment Guarantee Act 2005 (MGNREGA) was an astute political response to the absence of jobs in rural areas, but welfarism can never replace job growth.

Rural incomes were also propped up by minimum support prices, or MSPs, for several agricultural products. But political economy had to balance rural incomes with a concern for inflation, which was running at 12% by 2009. Increases in MSP and MGNREGA wages were both choked back, and by 2015, consumer price inflation tumbled to under 5%. The RBI called it “a favourable but unanticipated development that restrained cost-push pressures". But lower food prices also meant that, after 2014, rural wages barely kept up with inflation. The rural consumption boom, which had been a significant feature of India’s boom years, tapered off.

Demonetization deepened the deflationary impulses in the economy. The impact on economic growth is hazy because of issues around GDP measurement. However, the impact on employment is well-documented. The State of Working India 2019 report, brought out by the Azim Premji University, says: “Five million men lost their jobs between 2016 and 2018, the beginning of the decline in jobs coinciding with demonetization in November 2016, although no direct causal relationship can be established based only on trends." The implementation of goods and services taxes (GST) created additional stress among small and medium enterprises and deepened job losses.

Meanwhile, our exports of goods have also been slowing. From 2003 to 2008, Indian merchandise exports had grown by 25% per annum. Despite a blip in 2009, as a result of the global slowdown, they recovered in 2010. But after 2011, manufacturing exports have flagged. IT exporters have been the only bright light on the external front.

During the boom years, savings and investment were being funnelled into the economy at an unprecedented rate. By 2011, investment (measured by gross capital formation) had hit 40% of GDP. However, good times always make for bad loans. Much of this investment turned sour, as real estate players had hugely overestimated demand; revenue models for infrastructure were hugely flawed; and state governments refused to charge economic prices for electricity from new power plants. Bank balance sheets were stressed by these non-performing assets, but there was a widespread reluctance to recognize the distress. We preferred to “extend and pretend", hoping that time, inflation, and economic growth would save firms like Infrastructure Leasing and Financial Services Ltd.

But, as inflation, and then growth slowed, “extend and pretend" became more and more difficult to sustain. Under Raghuram Rajan, RBI also insisted that bad loans get recognized more proactively. When inflation is 10%, and real GDP growth is 8%, the resultant 20% growth in nominal corporate revenues and bank balance sheets hides many bad loans. When both slow, and nominal GDP growth halves to 8%, the warts start showing up. The malinvestments of the last decade became apparent, kicking off a balance sheet crisis, which is unfolding to this day.

What now?

With consumption slowing, and unemployment growing, GDP growth may slip even further from the recent low of 5%. Over the last quarter, the only bright spot was government expenditure, which grew at 8%. Households are in no position to catalyse growth—between job losses and low income growth, consumption does not look promising. Household savings rates have dropped, while credit card debt has surged by 26% in the last year alone. Both metrics point to consumers struggling to maintain their standard of living. Capacity utilization in the manufacturing sector is below trend, and doesn’t suggest that private sector investment is likely to improve any time soon.

This pattern of slowing consumption, low savings, and low investment can spiral downwards rapidly. Only government, with its ability to print money, can spend our way back to growth.

A major fiscal stimulus requires two major shifts in narrative. The first is recognizing the depth of the slowdown. Our government was slow in getting there, and till a few weeks ago, comments from our economic czars ranged from the defensive, “There is a global slowdown", to the optimistic, “Two quarters from now, we will be talking about a modal projection of 7%".

The second is to abandon the mantra of fiscal consolidation. Since 2014, the government has committed to bringing the centre’s fiscal deficit down to 3%. Launching a major fiscal stimulus required abandoning the “fiscal glide path". Again, the predominant narrative was against fiscal profligacy.

That was the case till 20 September, when finance minister Nirmala Sitharaman unleashed a massive corporate tax cut. The stock market reacted with justifiable cheer; the Nifty soared by 5%, a magnitude of change that normally presages a phase shift in markets. The government’s willingness to pivot on a dime is a huge signal of intent to support the economy.

There is no such thing as a free lunch, though. This tax party will cost the government significant loss in revenue, and raise the estimated fiscal deficit by roughly 0.7% of GDP. The budgeted deficit was already looking optimistic, with tax revenues up by only 6%, compared to an assumption of 18%. The government will have to borrow a great deal more to meet this gap. Unsurprisingly, bond markets reacted sharply on the day the corporate tax was cut, with yields climbing 15 basis points. Even if RBI keeps cutting the repo rate, they will not transmit into financial markets. Also, if global investors pull back from our bond markets, this could put pressure on the Indian rupee.

This massive corporate tax cut will put more money in the hands of companies. It will feed back into the system when they add productive capacity, distribute dividends, or drop prices. Given the low demand, capacity addition is still way down the road. Dividend distribution will take place with a lag, and impacts only a very small percentage of Indians. The shortest feedback loop of this stimulus will be, therefore, through lower prices (if it happens) that encourage consumer spending.

The way ahead

As an investor, I’m hoping that higher demand and the indefinable “animal spirits" lower the downside risk to equity prices. On a purely arithmetical basis, reducing taxes means a higher percentage of company margins flow to profits. Share prices should rapidly re-rate for the higher net profits. For several quarters, though, I’ve been reducing my exposure to Indian equities. While I’m not rushing to buy into the bull fervour, I now think there is a case to examine small and mid-cap shares that have been excessively beaten down. Some investment advisors believe our markets are bottoming out and this is a good time to enter the equity markets. I most categorically don’t.

By my reckoning, the increased fiscal pressure is very likely to impact the rupee too. As growth expectations continue to dip, foreign investors will withdraw from the Indian markets. In any case, the rupee needs to move sharply lower if our exports are to revive. With the Eurozone in trouble, the dollar will be the last man standing. One can buy the dollar in several ways, and I recommend all of them: Buy USD/INR futures on the National Stock Exchange; invest in shares of our IT exporters; buy gold, which is also a play on lower global interest rates; and buy US stocks, to the extent allowed under our foreign remittance scheme.

I plan to still keep money on the sidelines, for when I see the Indian markets bottoming out. I advocate the safety of fixed deposits and liquid funds in the meantime. Our debt markets are still far from risk-free. I wouldn’t bet on Indian government bonds either, until the fiscal position consolidates.

Lastly, and I’ve been doing this for a while, make long-term investments in the businesses of the future. New business models are disrupting every sector, from groceries to finance, and education to entertainment. Many of the business stars of tomorrow are not traded on public markets today, and won’t be for several years. But the passion and energy of our young ecosystem is highly energizing. If you possibly can, find a way to become an “Angel". Putting seed money into startups is both risky and demanding, but I’m finding it hugely rewarding. It is also my testament of faith in the long-term future of our nation.

Mohit Satyanand is a businessman and investor.

There was a spelling error in the graphic which was corrected on October 9

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