The Ministry of Statistics & Programme Implementation , Government of India announced the GDP growth numbers for 2019-20 financial year.
It can be seen that there has been a constant drop in the growth rate from 2016-17 onwards. The GDP growth rate of 2019-20 is the lowest in 11 years. It should be noted here that the impact of the lockdown due to COVID-19 was effective for only 7 days in FY 2019-20. Hence this drop in growth numbers cannot be only due to the lock down. It can be said that Indian Economy is showing a symptom of declining growth for almost 5 years now. Let us diagnose what are the reasons behind this symptom.
The major component of GDP are the Private Consumption expenditure (a measure for demand) and gross capital formation (a measure for investment). Together they constitute over 87% of the economy. What has been the trend in terms of demand and investment?
There has been a steady decline in growth rate of demand from 2016-17 onwards. From over 8% in 2015-16, the growth rate of demand has fallen to 5.3% in FY 19-20. The export demand also showed a sharp fall in FY 2019-20. This year there has been a sharp fall in investment growth and we witnessed a shrinking of investment. Now what explains the fall in growth of both demand and investment.
What will be the factors determining a decline in growth of demand?
- One, the people are holding onto their money and not spending it. In this case there will be a rise in savings.
- Two, there can be a decline in growth of personal income leading to a decline in growth of spending.
One of the measures of savings is the growth rate of bank deposits. It is seen that there has been a decline in the growth rate of bank deposits in FY 19-20. So with savings growth also falling along with the decline in demand growth, in all likelihood there might be a decline in growth of personal income.
What will be the factors determining the fall in growth of investment?
Investment growth can be impacted by the decline in growth of demand. Lower growth in demand will mean lower profit for the companies and lower investment. Since the Indian economy has been witnessing a decline in demand growth, this can be in all probability be the reason behind declining growth in investment. Successive governments in India have adopted investment friendly policies. Moreover the government reduced the corporate tax in 2nd quarter, FY 2019-20 in order to boost up investment. In spite of these investment friendly policies there has been a decline in the investment growth in recent past.
Lower investment leads to slow growth in industrial and services sector. Almost all of the non agricultural sector has witnessed a decline in growth rate in FY 19-20. It should be noted here that manufacturing and construction, the two most people intensive sectors apart from agriculture, witnessed the lowest growth among all sectors. This has a detrimental impact on employment scenario. As per the Annual PLFS data released by the Ministry of Statistics & programme Implementation, the country witnessed the highest unemployment rate in 45 years. This lower investment makes the problem of unemployment more severe.
Thus it can be said that both the decline in growth of demand and investment are very much linked to each other and one is leading to the other. This is more alarming given it is a vicious circle.
As is shown, lower demand growth leads to lower profit and hence lower investments. Now lower investments will mean a decline in growth of industrial and services sector leading to lack of jobs in the economy which further leads to lower demand. So a holistic view needs to be taken given this linkage between the lack of growth of demand and that of investment.
The diagnosis of the problem of steady decline in GDP growth for 5 years suggests that this is due to both the lower growth in demand and investment that Indian economy is witnessing. The question is what will be the most apt prescription to arrest this decline in GDP growth.
There can be three possible ways to address this issue. First, to focus on boosting demand in the economy, second, to focus on boosting investment in the economy and third to focus on both.
As has been mentioned above, the government has adopted host of investment friendly polices targeting specific sectors. A reduction in corporate tax rates were also announced in the middle of 2nd quarter of FY19-20. So the focus has been to boost investment. Moreover host of policies were taken to make banking credit available for industries. But there has been a decline in growth of bank credits also despite host of credit friendly measures.
The quarterly trends in investment growth in FY 19-20 suggests that these measures did not lead to a boost up in investment. The investment growth has shown a steady decline across the four quarters of FY-19-20.
Now as part of economic package to boost the economy given the pandemic induced lock down, host of credit measures have been taken. But as we see, credit measures or other investment friendly measures are not able to boost the economy. The reason lies in the flow explained in the diagnosis section. Investment cannot boost up unless there is sufficient demand in the economy.
The optimal way to address this issue will be to take host of measures that boost both demand and investment.
- Universal basic income or some income guarantee policies will ensure that people will have more have more cash in hand and hence they will spend more leading to more profit for industries. This will bring in investment.
- Along with this, host of infrastructural projects need to be undertaken. This will lead to more investments.
The combination of the above two measures will help break the vicious circle and will be able to address the steady decline in growth rate. However both these measures will mean a rise in government expenditure. The fiscal deficit in FY 19-20 has been 4.6%, higher than the budgeted target. The government needs to rationalize its spending and focus on measures to boost the demand along with boosting the investment. A balance needs to be maintained so that on one hand the fiscal deficit does not rise at an uncontrollable level and on the other hand measures are adopted to help the economy move out of the vicious circle.