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India’s first-ever slowdown at a time of political stability

Harish Damodaran
There has been no BoP crisis either; foreign exchange reserves were, in fact, at a record $448.6 billion as on November 22.

Sharp and protracted economic slowdowns aren't new to India. Since Independence, there have been at least eight episodes of significant GDP growth rate declines over two years or more-1961-62 and 1962-63, 1965-66 and 1966-67, 1971-72 and 1972-73, 1984-85 to 1987-88, 1990-91 to 1992-93, 2000-01 to 2002-03, 2012-13 and 2013-14, and the current one from 2018-19.

The slowdowns till the 1980s were mostly a result of drought-induced agricultural contractions, wars or balance of payments (BoP) pressures. Shortage of foreign exchange for imports, even of essential materials or components and spares used in capital goods, besides austerity measures introduced after the 1962 Sino-Indian War, caused the first growth dip episode. Back-to-back droughts and a BoP crisis leading to the 36.5% rupee devaluation of June 1966, likewise, precipitated the second downturn, while it was a combination of the 1971 Indo-Pakistan War and the 1972 famine in the case of the third. The 1980s saw three consecutive drought years-1985, 1986 and 1987. Its impact on the broader economy was predictable, given the farm sector had a roughly one-third share in India's GDP even at this point in time.

Only during the past three decades has agriculture's role in bringing down or pushing up overall growth diminished relative to other macroeconomic factors. Thus, both the early-1990s slowdown and the one in the last two years of the United Progressive Alliance (UPA) regime were preceded by "twin deficits"-on the fiscal and external current account fronts. The growth slump of the early-2000s during the Atal Bihari Vajpayee-led National Democratic Alliance (NDA) government had mainly to do with the after-effects of the 1997 Asian financial crisis, the sanctions imposed by the US and other countries following the 1998 Pokhran nuclear tests, and the end of a mid-1990s corporate-driven mini-investment boom.

The current slowdown-GDP growth has dropped in every quarter from January-March 2018 down to July-September 2019 and showing little signs of recovery-is unique by contrast.

Firstly, it has taken place amidst remarkable political stability, with the unquestioned leader of a single-party majority government at the helm. This was not so with the UPA, Vajpayee's NDA or the 1991 minority Congress government of Narasimha Rao. Narendra Modi's popularity is probably rivalled only by Indira Gandhi. But she was a relative novice as Prime Minister during the 1966 devaluation and emerged as a truly strong leader only after the 1971 general elections, which were held before the economy went into a tailspin. One could similarly argue that Jawaharlal Nehru was well past his prime when India's first major downturn happened. That leaves only Rajiv Gandhi, who took over after his mother in 1984. However, he never enjoyed the cult status or credibility that Modi today commands.

Secondly, this slowdown isn't courtesy the usual "F" suspects-food, foreign exchange and fisc. Not only does agriculture account for hardly 15% of India's GDP now, annual consumer food price inflation, too, has averaged a mere 1.59% between October 2016 and October 2019. There has been no BoP crisis either; foreign exchange reserves were, in fact, at a record $448.6 billion as on November 22. The Modi government may have deviated from the original schedule of reducing the fiscal deficit to 3% of GDP, but the average figure of 3.7% for 2014-15 to 2018-19 is much better than the 5.4% during the previous five years under the UPA.

The Modi period, if anything, has been marked by both political and macroeconomic stability. Nor has it been witness to "external" disruptions in the form of wars or oil price surges. Even the US-China trade conflict from 2018 is not comparable in its effects on the Indian economy to the 2008 Global Financial Crisis or the 2013 "taper tantrum". In any case, it's not as though India's exports were really booming before 2018.

Unlike all the earlier downturns whose precursors/triggers were supply-side constraints in food and forex, macroeconomic imprudence or external shocks, what we are now experiencing is more of a "western-style" slowdown exacerbated by internal policy misadventures. At the heart of it has been the twin balance sheet (TBS) problem-of debts accumulated by private corporates during the investment binge of 2004-11 turning into non-performing assets of mainly public sector banks. A similar bad loan build-up did take place even in the mid-1990s, forcing the subsequent cleanup of bank balance sheets and deleveraging by India Inc that also impacted growth during the Vajpayee government period.

But the difference between then and now is how the TBS problem, despite being flagged way back in December 2014 by the former chief economic adviser, Arvind Subramanian, has been allowed to fester-and spread to sectors such as non-banking financial companies and real estate that have far more contagion effect than steel, power or textiles. Even worse is the self-inflicted wounds from demonetisation and the unprepared rollout of the goods and services tax (GST), hitting those who were least responsible for the TBS problem: Farmers, petty producers and MSMEs. Job and income losses in the informal sector have, in turn, depressed consumption demand, including for the products of listed firms and other organised players that were supposed to have benefited from demonetisation and GST.

If indebted corporates, risk-averse banks and the more recent credit crunch resulting from defaults by the likes of IL&FS, Dewan Housing Finance and Altico Capital-these are threatening to spill over to other financial and real estate-linked entities-have come in the way of investment demand picking up, consumption also taking a hit makes for a gloom-and-doom narrative.

The irony, of course, is that all this comes at a time of great political as well as macroeconomic stability. This is, indeed, a first-of-its-kind slowdown in India, where food, foreign exchange, oil, war and other "supply-side/external" factors have had no role. And if economic history is any guide, Western-style slowdowns, which are largely about crisis of confidence, sentiment and "demand", tend to be long-drawn-out affairs. Controlling inflation may be easier than getting consumers to spend and firms to invest.