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The Central Statistical Organisation (CSO) released its economic growth data about India’s GDP growth rate slipping to 5% in Q1 of FY 20, the lowest in six years.

This was not unexpected as it had been 5.8% in the Q4 of FY 19. The economy has been slowing down for, at least, the last six quarters.

The situation got special attention when Prime Minister Narendra Modi announced the target of reaching the $5 trillion mark by 2025 for the Indian economy. To reach the target, India needs to have at least 8-10% average growth of GDP per year for seven consecutive years. A section of observers have lost hope of achieving it. Another section thinks that even if the target is reached, that would only be helpful for Indians if the nature of growth attained is inclusive. 

Reasons behind the slowdown

A major reason behind the economic slowdown has been increasing rural stress. Analysing the latest available Labour Bureau data, Himanshu, Associate Professor, Jawaharlal Nehru University, recently pointed out in an article published in a national daily that the real wages in agriculture (average of all agricultural occupations) has declined by 0.5% per annum in the two years till June 2019. Even the wages of the non-agricultural sector has been stagnant in that period. Himanshu reached the conclusion by analysing India’s consumption expenditure data. That showed that real consumption in rural and urban areas declined by 4% per annum between 2014-15 and 2017-18. The crisis in the rural sector is more pronounced because inflation has exceeded 4% in the last four months in the urban sector whereas it has been near zero in rural areas. Zero inflation does not convey any positive meaning - it is a weakness. The rural stress prevailing in India now is a structural one and can be corrected by several fiscal measures - long term and short term. Another very significant thing responsible for rural stress that Himanshu has mentioned in his article is that the terms of trade has turned sharply against farming in the last two years. This has also been a structural issue.

Another important reason for the weakening economy has been the slowdown of domestic savings. A recent CRISIL report points out that the overall savings rate fell to 32% in fiscal 2018 from a peak of 37% in fiscal 2008 with a steep fall in household savings rate. The household savings are currently at 6.6% of GDP and foreign savings at 2.4%. This indicates towards availability of total financial savings of 9% for financing government deficit (6.6% of GDP) and private investment.

Coming to other sectors, one can look at an editorial article of a leading national business daily which states that the fall of rural demand due its crisis along with signs of job attrition in urban regions, perhaps, explained the 0.6% growth of the manufacturing sector in April-June quarter as against 3.1% in the March quarter. At the same time, capital formation grew only by 4% in Q1 of this FY. This is not only a present problem; it will have a negative economic consequence on the future growth of the economy.

Steps to reverse economic slowdown

A section of economists thinks that the first thing is to increase the demand expenditure in the rural areas by creating rural infrastructure like roads, schools, hospitals, irrigation, housing, other public spending to generate employment in the rural sector. At the same time, the government has to take the correct fiscal policy to create enough jobs which may increase the savings of the economy. This may take a long time but it will have to be taken with immediate effect. Additionally, more attention is needed for production of goods and services of high mass consumption. That will enhance the market of the economy through multiplier effect.

Policies taken by the government may not rescue the economy

A section of economists and observers consider that the recent government policies of tax concession to the super rich, relief to the motor vehicle producers and purchasers, tax relief to the foreign investors may have limited impact in enhancing the growth of GDP. The decrease in interest rates may also have a very limited impact on the economy. This is because low interest rates mean reduction of cost of production. Text book economics teaches us that if rate of interest falls, there is a tendency of a rise in investment because this lowers the cost of investment. But this is only possible when certain other economic conditions are favourable. 

But at present, India’s economic situation is different. There exists excess capacity in different sectors by about 30%. The demand deficiency in the economy has been very pronounced in most of the sectors. In this situation, lowering interest rates will have almost no impact as the investors may not find investment profitable. The purchasing capacity is to be enhanced to reverse the slowing economy. In this case, low interest rates may worsen the situation. The income of a section of people largely depends on interest income. In that case, income of that section may fall. Moreover if rates of interest fall, then the deposit interest rates on banks will fall in consequence because common people may go for investment wherever they like. They may look for risky investment schemes. In that case CASA (the cheapest source of funds) of the banks may fall. So reduction of rates of interest is not an effective policy.

Banks’ mergers

The banking sector in India, particularly the public sector banks (PSBs), has been in crisis. Their unrecovered loan (NPA) is about 10% of the total lending. But their financial situation has been improving. There has been some restrictions on a few ailing banks. The Prompt Corrective Action (PCA) was imposed on nine PSBs depending on three or four financial criteria. Some have been able to get out of that restriction due to better performance. Actually on the whole, the banking industry has been improving as many banks have started making profit. Even in the worst phase of the crisis, most of the PSBs earned operating profits. The losses of the PSBs have been due to high provisioning of unrecovered loans of the earlier years.

Reasons for merger

The reason behind the banks merger is not clear to many economic observers. The Indian government considers that big banks are essential for financial efficiency. To attain the target of $5 trillion economy by 2025, India needs to have very big banks. Merger of PSBs is the way to this. But experience of mergers has not always been bright. In most of the cases, the merged banks had to suffer. The merger of SBI with its associate banks a few years ago resulted in a loss of `6547 crore in the 2018 fiscal.  A few days ago Soumya Dutta, General Secretary, All India Bank Officers’ Confederation (AIBOC) pointed out in a memorandum to the Director, Punjab National Bank that former RBI Governor Raghuram Rajan had termed bank merger as a “non-solution” to the NPA problem. He also quoted Rajan as saying, “We need concentrated attention by a high level empowered and responsible group set up by government on cleaning up the banks. Otherwise the same non-solutions (bad bank, management teams to take over stress assets, bank mergers, and new infrastructure lending institutions) keep coming up and nothing really moves. Public sector banks are losing market share as NBFCs, Fintech companies, payments banks, the private sector banks gain ground.”

The memorandum also pointed out that how the financial position of the PNB will worsen after the proposed merger. “As things stand today the combined balance sheet of the proposed new entity will have a CASA ratio of 40.52% (existing 42.16%), CRAR ratio 10.77% (existing 9.73%) and net NPA of 6.61% (existing 6.55%) which could only worsen further in the current fiscal.”

Professor Jayati Ghosh of Jawaharlal Nehru University told BE that there were a huge number of successful small banks everywhere in the world. Banks’ size had nothing to do with efficient lending. The proposed bigger banks would mainly serve the interests of the big borrowers and crony capitalists. This would increase inequality and the vulnerability of the economy. She expressed her doubts over the intention of the merger and said that in a few months, the government might propose for privatisation of the big banks in the name of better efficiency.