The Indian Economic Slowdown
Updated: May 4, 2020
The Indian Economic Slowdown
Written by: Earth Chadha
What Is Recession
Recession is generally defined as a period of negative growth of the gross domestic product (GDP) for more than two quarters in an economy. The triggers of rescission are uncertain but generally include a cluster of business errors being realized simultaneously. Due to these errors firms are forced to reallocate resources, scale back production and sometimes even lay off employees.1. Other triggers include inflation. In an inflationary environment, people tend to cut out leisure spending, reduce overall spending and begin to save more. As businesses reduce expenditure in order to curtail costs, the gross domestic product declines and unemployment rates rise thus leading to less money flow in the economy.
Effect of the NBFC crisis on the Indian Economy
India currently is facing a same type of situation of forced reallocation of resources which was triggered by the Non-Banking Financial Companies (NBFCs) crisis. NBFCs are financial institutions that offer various banking services but do not have a banking license. Thus, these institutions are not allowed to take traditional demand deposits. They are generally in the business of loans and advances, acquisition of shares/stocks/debentures/securities, leasing, hire-purchase, insurance business, chit business etc.2. NBFCs generally borrow money from banks or sell commercial papers to mutual funds to raise money. The money is then given as a loan to small and medium enterprise, retail customers and so on. But when NBFCs face liquidity crunch – this leads to NBFC crisis. There are two main reasons for the liquidity crunch.
1- NBFCs raise short-term funds which are lent out as long-term loans.
Now every time the NBFCs must raise fresh loans to repay the old debt. This exposes the NBFCs to interest rate risks
2- The credit cycle was broken by default of some firms of the IL&FS
Group (One of the largest NBFCs in India)
Due to this default many companies refused to provide any future funding to the IL&FS group. The cost of funds rose by 150 basil points for NBFCs.3.
The NBFCs liquidity crisis was and still is a huge contributor to the slowing down of the Indian economy. The liquidity crunch led to a shortage in the supply of funds to many major sectors such as real estate and automobile and the. The Indian sentiment of using their savings and partially borrowing for the two status symbols a car and a house were hurt badly.
The real estate sector faced a lack of cash flow to continue to develop and construct ongoing projects as neither the banks nor the NBFCs nor was their customer base ready to lend to them. There are steps being taken to match the mismatched cash flows such as introducing the highly scarce equity capital in the industry.
After the real estate sector, the sector hurt the most by the NBFCs crisis was the automobile sector. As NBFCs were primarily lending to semi-urban and rural areas where credit availability from banking is generally difficult a liquidity crunch led to high interest rates and thus a shortage of funds for the customers. Although there are many other reasons such as the introduction of new emission norms, New regulatory and safety norms etc. that have led to a 41% decline in the sector but the NBFCs crisis is the major one. Although the automotive sector is seeing a gradual rise in the demand due to incentives and offers by the manufacturers but clearly it is not enough.
Nature of India’s Economic Slowdown
The obvious question to ask after knowing all of this is whether the slowdown is cyclic or a structural one and weather the fifth largest economy is heading towards a recession.
Economists suggests that the slowdown is a both structural as well as cyclical. They say that the NBFCs crisis and the elections had an impact on the economy which can be categorized as cyclical.
According to them the issues that are causing a structural slowdown include income growth in the urban as well as rural areas. In urban areas the income growth has been lower than expected in the past few years causing a hit on the consumers’ savings and lowering the future growth expectation thus hurting their current sentiment of spending. In rural India the period of 2014-2019 hasn’t been the best for agriculture apart from the second half of 2016, out of these 6 three years have been drought years. Even in the second half of 2016 agriculture the rural population is not able to realize good prices for their harvest due to steps taken by the government such as such as demonetization. All of the above factors have congregated at this point of time and the combined impact of them is now visible in terms of a consumption slowdown.
Steps Taken by the Indian Government
The Modi government seeing the entire economic ruckus has taken huge steps to revive the economic growth. Some of them include:
1. In order to enhance investment in the capital market the government decided to withdraw the enhanced surcharge levied previously on long- and short-term capital gains arising from the transfer of equity shares
2. The government released seventy thousand crores into the public sector banking system and additional lending and liquidity to the tune of five lack crore can be made available by providing upfront capital. This measure is taken to end the liquidity crisis and as a measure of bank recapitalization. This measure is expected not only to benefit the banks but all the cooperates, retail borrowers, MSMEs and small retail traders as well
3. The government ensured that the interest rate cut by the central banks will be passed to the consumers. This step was taken in order to lower the car and home loan EMIs and thus boost the automobile and housing sectors.
4. Angel tax is a tax which is levied on private companies that raise funds at a rate higher than its “fair valuation”. Currently the rate is 30%. Startups have now been exempted from this tax.
5. The cooperate tax rate has been slashed from 30% to 25.2% for previously established domestic companies and to 17.01% for newly established companies to spur economic growth.4.
Future of the Indian Economy
The steps taken by ruling government seem to be working out as the manufacturing sector has seen a turn in the month of November and seem to be on a growth spree through December. With new orders rising, companies have ramped up production and resumed hiring efforts. There is also a renewed upturn in input buying.
Four of the five sub-components of the PMI increased in December. At the subsector level the growth is led by consumer goods though intermediate goods also made a stronger contribution to headline figure. The uptick in total sales was supported by higher demand from overseas.
While on one end the government is doing it’s best at aiding the economy the current situations of social unrest in the country in addition to international economic outlook of the recent years on the other end are constantly pulling it down. The Indian economy appears to be in the state of limbo.The future of the Indian Economy is foggy and its goal of becoming a five trillion-dollar economy by the year 2025 seems farfetched with the current economic growth rate of the country.
CHIZOBA MORAH ( 2019, June 25) What Causes a Recession? Retrieved from https://www.investopedia.com/ask/answers/08/cause-of-recession.asp
JAMES CHEN (2019, MAY 21) Non-Banking Financial Companies – NBFCs. Retrieved from https://www.investopedia.com/terms/n/nbfcs.asp
Aarati Krishnan (2019,June 2019) NBFC crisis: A reality check. Retrieved from https://www.thehindubusinessline.com/opinion/columns/aarati-krishnan/nbfc-crisis-a-reality-check/article28189944.ece
Anupriya Thakur (2019, August 23) Finance minister Nirmala Sitharaman announces raft of measures to boost economy, more steps on anvil. Retrieved from https://www.indiatoday.in/business/story/finance-minister-nirmala-sitharaman-announces-raft-of-measures-to-boost-economy-more-steps-on-anvil-1590974-2019-08-23