Tackling India’s economic slowdown

Context:

  • India’s GDP growth has decelerated to 4.5% in the second quarter. Neither consumption nor export and private investment are supportive.
  • In fact, India’s economic growth is being driven by government expenditure. Excluding the government part that comprises not more than 13%, the Indian economy grew just 3.05% in the July-September quarter.

Slowing GDP growth will lower tax collections, and even cap the government’s ability to spend and support growth.

Global Headwinds:

The government has been hinting that the global headwinds are behind sluggish exports, and this is not without reason.

1. US has removed India from the US GSP (Generalized System of Preferences) beneficiary list, with adverse implications for export items such as chemicals, pharmaceuticals and engineering goods
2. The American tightening of immigration rules dampens Indian information technology (IT) export prospects.
3. The European Union (EU) is struggling with Brexit, and slowing growth in its larger economies such as Germany.
4. The Middle East—another major export market for Indian merchandise—is troubled by its over-reliance on oil and the regional political turmoil.

Sluggish merchandise exports:

  • India’s merchandise exports have been hovering around $300 billion for a very long time. The figure stood at $305 billion in FY12, and it will be no different in FY20
  • Obviously, the problem is internal mismanagement. Countries such as Bangladesh and Vietnam are fast replacing India in the products the latter has traditionally dominated; for example, apparels
  • India’s textile majors such as Arvind and Raymond are silently shifting their production base to Ethiopia to take advantage of cheaper labour and electricity, and duty-free market access in top consuming markets.
  • Vietnam, in fact, is far ahead of India in attracting top electronics manufactures and, in turn, it is now pushing electronics exports as well

Factors responsible for slowdown in consumption:

  • Continuing rural distress, which was accentuated first by the note ban and then by domestic and global supply gluts, is now capping rural demand.
  • The wholesale prices of most agricultural crops are 15-20% lower than their MSP(minimum support price), while the prices of major farm inputs and equipment have gone up by 10% or so. This is squeezing margins and, in turn, farmers’ incomes and their demand for goods and services.
  • High taxation and regulatory rent-seekingin sectors such as automobiles and real estate are aiding the demand slowdown. For instance, effective taxation is up to 50% for automobiles.
  • Similarly, high GST (goods and services tax) on key inputssuch as cement, protectionism-induced high-priced steel along with prohibitive stamp duty and registration charges are keeping home prices inflated and the demand for them capped. This hampers the prospects of dependent industries.
  • Rising household debts and credit crunchin the shadow banking space are further contributing to the demand slowdown
  • Investment, as measured by the gross fixed capital formation (GFCF), grew by a meagre 1% in Q2FY20, even as its share in GDP continued to decline.

Measures needed to revive consumer demand:

1. The GST Council should increase GST on low GST items with inelastic demand, and reduce GST rates for high GST items with elastic demand. That will reduce rate differentials and discourage GST evasion and corruption.That will also boost the overall consumer demand.
2. As reviving demand remains the key to reviving private investment, reducing income tax rates for lower-income people, if not for all, can be a big sentiment booster
3. Keeping import duties high, especially on key industrial raw material such as steel or polyester and synthetic fibres, hurts downstream industries and induces import of high-value finished goods—this adds to the import bill. Similarly, a stronger rupee encourages imports and hurts exports.
4. Therefore, a weaker rupee rather than high import dutieswill provide protection to domestic manufacturers and yet improve India’s export competitiveness.
5. In addition, liquidity situation in the shadow banking space must improve. One key supply-side measure that can help even in the short term could be a genuine attempt to reduce the compliance burden for SMEs.

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