It is a well-known fact that in
the last five years, the Indian economy has slowed down considerably. GDP
growth between FY13-FY18 has averaged 7% (under the new series) which pales in
comparison to the 9% average growth (under the old series) registered during
FY04-FY11. Also well-known is that the slowdown has been brought about by a marked
decline in domestic capex activity as well as stagnant exports. After gaining
market share by over 1.5% during the last decade, India’s total exports as a %
of global trade has plateaued at 2% for the last many years (Chart 1). However,
more noteworthy, is the unusually large decline in capex activity which the
economy has experienced in recent years. Thus, while Gross Fixed Capital
Formation (GFCF) grew at roughly 2x the rate of GDP growth between FY04-FY11, its
growth has now fallen much below GDP growth in the last few years.
Chart 1: India’s share in world
trade has stagnated
With
two major engines of the economy moving in slow-motion, needless to say,
private consumption has been the sole driver of economic activity in the
current decade. In fact, what is striking, is that the share of private
consumption in GDP has declined in every single decade, since independence,
except the current (Chart 2). There is no doubt that consumption has provided
the much-needed lifeline to the economy at a time when other engines have failed
to fire. Generally, in an economic recovery, first consumption picks-up which
in turn leads to better capacity utilizations and consequently leads to pick-up
in capex activity. Therefore, consumption led growth is not bad per se. However,
in India’s case, while consumption has undoubtedly supported growth, it has
also resulted in the emergence of certain structural imbalances. These
structural imbalances if not addressed can have serious implications for the
long-term growth potential of the economy and can turn the “Great Indian
Consumption Story” from a boon to bane.
Chart 2: Rising Private Consumption (% of GDP)
These imbalances have manifested itself
in mainly two forms:
- Consuming more of what is not domestically produced: India’s consumption profile seems to be increasingly misaligned with its production profile. A testimony to this is the continuous rise in India’s non-oil non-gold trade deficit in the last few years (Chart 3). It has always been convenient to blame oil and gold imports for India’s external vulnerabilities. However, beyond the oil curse, what is being ignored is the steady deterioration in the composition of India’s import basket. In fact, electronic goods appear to have become the new gold with electronic imports more than doubling since the start of 2010. While a weak commodity cycle has masked India’s external vulnerabilities in the last few years, underlying trade balance has continued to worsen. As the support of benign commodity prices wane, the economy could become increasingly susceptible to an external shock.
- Declining household savings rate: In most emerging economies, out of the three stakeholders, savings by the household sector tends to the be the largest and the least volatile component of the overall savings rate. While corporate and government savings fluctuate with the business cycle, household savings are generally determined by more structural factors like demographics. In India, household savings rate has been on a rising trend ever since data is available (from 1950s onwards). It is only since 2010 that this trend appears to have broken with household savings rate declining continuously (Chart 4). A possible explanation is that in the absence of any significant income growth in the last 5 years, households have increasingly started to substitute savings with consumption. Moreover, higher consumption can be supported not only by withdrawal of savings but also higher debt. This too appears to be happening with household debt in India rising recently (albeit from very low levels).
Chart 3: India's worsening non-oil non-gold trade balance
Chart 4: Declining Household Savings (% of GDP)
What are the implications of the
above?
For the last many years,
discussions of India’s growth have centred on one simple question: how soon
will the economy revert to 8-10 percent growth? The question is at times posed
as if such a reversion is a fait accompli,
a phenomenon just waiting to occur. Perhaps it is even just around the corner,
given all the structural reforms the government has implemented in recent
years.
However, history suggests that no
economy has been able to achieve consistently high economic growth without
accompanied by rising savings rate. The economic success of many East Asian
economies is a case in point. Experience of these economies show that during
the phase of good demographics, household savings rose sharply. This in turn
led to higher investments and propelled these economies into a higher growth
trajectory (Chart 5). On the other hand, in many LATAM economies (Brazil, Argentina,
etc.) despite favourable demographics, household savings rate remained stagnant
with households substituting savings with consumption. Not surprisingly, this
led to creation of several macro imbalances (high interest rates, high
inflation, high CAD) with the economies falling into what is known as a
“low-income trap”.
Chart 5: In China, savings & investments grew during phase of good demographics
Chart 6: This did not happen in case of Brazil
India is at the cusp of realizing its own
demographic dividend. It therefore becomes imperative to exploit this phase of
good demographics optimally to prevent the economy from going the "LATAM
way". However, household led current account imbalances which result from
declining household savings rate are difficult to tame. Also, it is not ideal to solve
it by stifling the consumption engine through contractionary policies. This is
because such policies (be it fiscal or tighter monetary conditions) tend to have
a greater adverse impact on capex activity rather than making any significant
dent on consumption trend. Instead what is required is a supply side response,
i.e aligning the country's production profile with its consumption profile.
“Make in India” cannot remain a mere slogan. “Make in India by Indians for
Indians" is the urgent need of the hour. For this, a collective effort by
all stakeholders including the RBI and the Government is needed. A clear vision
and execution strategy to achieve the right growth mix cannot be compromised
for any other objective.
