India’s finance minister Nirmala Sitharaman, who is slated to present the country’s annual budget tomorrow (Feb. 1), has her task cut out.
Economic growth is at a multi-year low. Neither five consecutive rate cuts by the central bank last year nor a cut in corporate tax rates in September has been able to revive consumption. If anything, the tax cuts have only led to a loss of $20 billion in revenue this financial year.
The lower-than-estimated tax receipts do not augur well. The economy urgently needs higher government spending to create jobs and arrest rural wage erosion.
If at all Sitharaman heeds the call to loosen the purse strings, it will have to be through higher borrowings, which will then jeopardise fiscal deficit targets. Clearly, the finance minister is in a Catch-22 situation.
Some of the following economic indicators best capture her dilemma.
Official estimates peg India’s GDP growth in financial year 2020 at 5%, the lowest in 11 years. In her first budget, presented in July 2019, Sitharaman had set a goal of making India a $5 trillion economy by 2024. That, however, requires the economy to expand at between 8% and 9% annually.
What measures Sitharaman takes to revive the world’s former fastest-growing major economy will be keenly watched. More than anything, Budget 2020 has to calm nerves.
Consumption forms the bedrock of the Indian economy, accounting for over 60% of overall GDP. The fall in consumption expenditure growth, from 17.5% in financial year 2012 to 9% in 2019, has been steeper than the decline in GDP growth.
Eroding rural wages and joblessness have contributed to the decline. “Rural consumption slump is on account of lack of employment, especially in the construction sector,” said R Nagaraj, a professor of economics at Mumbai’s Indira Gandhi Institute of Development Research (IGIDR). Lower fund allocations to India’s rural employment programme, under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), is also to blame, he added.
Lack of credit is another reason for weak consumption.
The Narendra Modi government has been unable to tackle the issue of bad loans, which have only increased under its watch. Wary of non-performing assets (NPAs), banks have been playing safe.
Aggravating this situation is the crisis in India’s shadow banks. “Nearly 20% of the credit extended by non-banking financial companies (NBFCs) goes to the retail segment. NBFCs faced problems in obtaining liquidity, which may have hampered their lending,” said Rucha Ranadive, economist at CARE Ratings.
Consequently, credit growth for India’s commercial banks has been falling.
Risk-averse banks have created a liquidity crunch. Investment, thus, has declined from 34.3% of GDP in financial year 2012 to an estimated 28.1% in 2020.
In December 2019, retail inflation in India soared to 7.4%, the highest since July 2014. Prices of food items rose 12% in the month due to supply disruptions following erratic monsoons.
Retail inflation is now well above the Reserve Bank of India’s comfort zone of 4%, limiting its ability to cut rates further. In 2019, it cut the repo rate, at which it lends to commercial banks, by a cumulative 1.35 percentage points.
However, the upward inflationary trend may not persist. “Prices of food articles have declined in retail markets as fresh crop has entered. We are likely to see a trend reversal in retail inflation in the coming months,” said Sushant Hede, associate economist at CARE Ratings.
Meanwhile, core inflation, which excludes the prices of food items, was on a steep slide in 2019. The fall best captures the dire consumption demand scenario.
India’s industrial output contracted for three consecutive months from August 2019. The fall in the index of industrial production (IIP) in September was the steepest in six years—one more sign that the economic slump is deep-rooted.
In Budget 2019, Sitharaman had sought to limit fiscal deficit, the difference between the government’s expenditure and revenues, to 3.3% of GDP. With lower-than-expected tax collections in the ongoing financial year, this target may be missed. “We are expecting a fiscal slippage by around 0.5% in FY20,” said Hede.
That leaves little room for Sitharaman to increase government spending, without giving a pass to fiscal deficit targets.
Growth, though, should take precedence, according to Nagaraj. “This is not the time for fiscal orthodoxy. Getting output and employment growth going again should be the priority. So, I think the government should allow the fiscal deficit to widen within tolerable limits. With improved output, the ratio will correct in due course.”
However, there is a flip side. “The widening of fiscal deficit could lead to additional borrowing by the government. This could result in the crowding out of private investors,” said Deepthi Mary Mathew, economist at Geojit Financial Services.
Despite the spate of bad economic news, financial markets have been scaling dizzying heights. In 2019, the benchmark Sensex rose 14%.
“The current rally is driven only by a few stocks. Most of the small- and mid-cap stocks underperformed last year,” said Mathew.
Yet, Sitharaman would not want to take investor optimism for granted. The rally, after all, is pegged on the hope that growth will revive. “Markets are seen to be driven primarily by expectations of an improvement in corporate performance and the announcement of policy measures to revive the economy,” said Ranadive.
The rare silver lining for the economy has been India’s steep ascent in the World Bank’s ease of doing business list.
In 2015, the government set a target of breaking into the top 50 by 2020. India is now within touching distance of the goal.