India’s Economy

It is now clear that India’s economy has begun to slow. In his conversations with various companies, your columnist was told that consumer demand across several segments is fraying and this is further reinforced by numerous surveys, including, but not limited to, the Business Confidence and Performance Index, undertaken by IMA. The question really is, why this is happening and what can be done to reverse the trend? Over a period of the last 7 to 8 years, the Government of India has done a remarkable job in building robust infrastructure, including roads, airports, ports and railways. All of these are eventually bound to reduce logistics costs and help better integrate supply chains. The effect will reflect, in a sturdier sustainable growth story, in the longer term, but a number of niggling issues need to be fixed.

Industry requires a wide degree of latitude to operate and one important aspect is concerned with regulation. Progressively, the regulatory ecosystem has become irksome with compliance headaches across different functions, such as the capital markets, tax enforcements and other onerous obligations that are proving to be tedious. Policy makers need to have a hard think on regulatory issues and why policies are framed, specifically by the Securities & Exchange Board, on the basis of the lowest common denominator, rather than adopting a soft touch approach that allows businesses a level of flexibility. The framing of rules and the implementation of the Digital Data Privacy Act, will further muddy the waters with a new set of onuses imposed upon industry.

The big worry for the Government is the rising level of unemployment, specifically amongst the youth. The way to fix this is through higher investment and capacity creation by industry, which will shift economic gears into a virtuous cycle. But oddly, businesses have largely refused to invest and complain of under capacity utilisation, which inhibits further expansion. The financial risk of investments going sour, far overrides the risk of a loss in market share. In a rapidly growing economy, the converse is generally true.

The latest GDP numbers paint a subdued picture. Between July and September, India's economy slumped to a seven-quarter low of 5.4%, well below the Reserve Bank of India’s forecast of 7%. While it is still robust, when compared with developed nations, the figure certainly suggests a slowdown. Economists attribute this to several factors. Consumer demand has been tepid, private investment sluggish for years and government spending – an crucial driver in recent times – has been pulled back. India's goods exports have struggled, with their global share standing at a mere 2%. Fast-moving consumer goods companies report shrinking growth, while salary bills at publicly traded firms, a proxy for urban wages, shrank last quarter. Even the previously bullish RBI has revised its growth forecast to 6.6% for the year 2024-2025.

India's inflation surged to 6.2% in October, mainly driven by high vegetable prices. Some would argue that the central bank's focus on curbing inflation has led to excessively restrictive interest rates, potentially stifling growth. But the RBI has a mandate to maintain price stability and we agree that inflation comes with higher risks, has the habit of entrenching itself and affects the sustainability of longer term growth. Still, high rates make borrowing more expensive for businesses and consumers, and potentially reduces investment and dampens consumption, both key drivers of economic growth. The RBI has kept interest rates unchanged for nearly two years, primarily because of rising inflation, which at 6.2% breached the central bank's target ceiling (4%), reaching a 14-month high. It was mainly driven by food prices, comprising half of the consumer price basket.

The issue is what can be done to ensure a boost to economic growth? The answer is sustainable growth requires long-term policy shifts. For a start, industry needs to be assured that the government has their back and this assurance comes with a stated policy on soft touch regulation. Second, in a number of industries such as chemicals, metals, glass, fibres and plastics, business managers grumbleabout consistent dumping from China, with the commerce ministry taking over a year or longer to impose additional import duties. Even where demand is rapidly rising, investors are sceptical to create new capacities, for the fear of cheap competition from imports. On its part, the government may need to hasten its processes, when remedial recourse is sought by Indian industry.

Third, the government needs to find ways to reduce its current account expenditure and the fiscal deficit. India’s public debt close to 90% of GDP is excessively high for a developing economy and that crowds out private capital. According to research undertaken by Carmen Reinhart, currently of Harvard University and previously the Chief Economist of the World Bank, when the public debt of a nation exceeds 70% of GDP, its longer term growth potential stands undermined. This is logical, as it is a generally accepted fact that the private sector, driven by competitive market considerations, is more efficient in utilising capital than the government. Inevitably, higher levels of public debt lead to higher taxes and these lead to lower investment and consumption.

Finally, flexible labour markets are the basic premise for higher employment. An example of how this works, in the economic interests of a nation, is Bangladesh, which assumed the lead position in garment exports as manufacturing moved out of China. Seasonal shifts in fashion, lead to cyclical operations amongst manufacturers where factories fire on all cylinders for a part of the year and lay-off workers, for a few months, before rehiring them again. This sort of flexibility in employment practices is the key reason for the growth of this industry. In India, this is not possible due to regulatory constraints.

As large companies come under the impact of falling sales and reduced margins, their tier 1 and tier 2 suppliers take the brunt of cost cuts. Most are SMEs and do not enjoy the flexibility of ampleliquidity and cheap money. With a slowdown comes job losses. The pain of an economic correction is far greater on small businesses as they lack resources to stay invested until better times return. They simply wind down operations or, even worse, shut shop as debt and costs become unsustainable. If the economy fails to recover on to a higher growth orbit, this problem gets worse and brings social and political consequences.

The economic ministries and Reserve Bank, need to have a hard think on structural shifts in policy and regulation. The Reserve Bank on its part must widen mediation in the banking industry, by allocating more licences to banks, to increase competition and lower spreads on capital. The RBI has not been generous in this regard with only a handful of new banks being given permits to setup shop. Foreign banks complain of an uneven playing field and compliance nightmares. Many, including Citi Bank, that has been in India for over a hundred years, have either shut shop or reduced their commitments to the market place. This cannot be construed as good news. Frankly, everything that needs to be done, to boost economic productivity, can be written on half the size of an A4 sheet. But actually doing it is much harder. There are political compulsions and worse, bureaucratic meddling comes in the way. These are, in a democracy, quite tricky to manage.