Budget meets slowdown: Govt's challenge on Feb 1 is to revive demand

What the Budget does to revive demand will determine if the economy can shrug off slowdown and regain momentum.

The year that will end in a couple of weeks from now has offered little cheer for the Indian economy. Yes, there was some celebration over the sharp cut in the rate of corporation taxes, the announcement of an ambitious privatisation plan, a fresh momentum to resolution of insolvency and bankruptcy cases, and the rollout of a streamlined and simplified set of new labour laws. But the Indian economy’s macroeconomic numbers showed no signs of any improvement during the entire calendar year.

Economic growth has fallen every quarter during 2019. Exports have contracted. Retail inflation has begun to show signs of firming up. The Reserve Bank of India (RBI) has cut the repo rate by 135 basis points, yet credit disbursements have seen no increase. Tax revenue growth has slowed. The newly launched goods and services tax (GST) is yet to stabilise as the revenue collection growth has stayed well below the desired rate. Even the big-ticket privatisation plan, announced in the middle of the year, has failed to make headway. And the Union government’s fiscal deficit has threatened to breach the targeted figure for the full financial year.

What then is in store for the Indian economy in 2020?

Growth of India’s gross domestic product (GDP) began decelerating from the first quarter of 2018-19. From 8.1 per cent in January-March 2018, it fell to 8 per cent in April-June 2018 and consistently decelerated to 7 per cent, 6.6 per cent, 5.8 per cent in the subsequent quarters of the last financial year. In the first half of the current financial year (2019-20), GDP growth maintained a southward trend with 5 per cent in April-June 2019 and 4.5 per cent in July-September 2019.

Slow recovery

The big question that now surfaces is whether the Indian economy has reached a level that is so low that it would soon start bottoming out. Undeniably, there are some positive indicators to endorse expectations of a slow but tentative recovery.

The advantages of a low base effect should start kicking in from the third quarter of 2019-20. By the third quarter of 2018-19, GDP growth had already fallen to 6.6 per cent. It fell further to 5.8 per cent in the fourth quarter of last year. Therefore, it would not be surprising for the GDP growth to recover in October-December 2019, from a six-year low of 4.5 per cent, recorded in July-September 2019.

Agriculture, though accounting for less than 15 per cent of GDP, has shown signs of a revival. Rabi sowing has improved, the progress of the north-east monsoon has been encouraging and the water storage in major reservoirs has been reported to be higher than the last year’s level.

On the manufacturing side, the purchasing managers’ index in November 2019 showed an improvement to 51.2, compared to 50.6 in October. Any upward movement from 50 in this index is a positive sign. Production of fertilisers, steel and even automobiles has begun witnessing a mild revival.

Other high-frequency indicators for the services sector have begun to show an uptick, with the purchasing manager’s index for services moving to an expansion zone to 52.7 in November. Net foreign direct investment in the first half of 2019-20 rose to about $21 billion, compared to $17 billion in the same period a year ago – a rise of over 23 per cent. Net foreign portfolio investments and flow of external commercial borrowings, too, have seen a significant rise.

Corporate results during the first half of 2019-20 provide another reason for hope. The funds mobilised by a sample of over 1,500 companies show that these were used for creating capital assets or investments in building fresh capacity. Taken together with the pick-up in resolution of stressed loans and acquisition of indebted companies by new promoters, the investment sentiment in the economy may see an improvement. What will help sustain this sentiment is an improvement in the pace of transmission of the 135-basis points reduction in the repo rate, making the cost of money for new projects a little more reasonable.

Demand isn’t improving

Yet, there is weakness in domestic demand conditions. Even as retail inflation rises to cross the 5 per cent mark, the core retail inflation (excluding food and fuel) has moderated, showing that there is lack of adequate demand in the economy. Manufacturing firms are yet to report any significant broad-based improvement in demand for their products. Exports have also failed to pick up, recording a two per cent drop in the first seven months of 2019-20. A significant recovery in exports is dependent on a host of factors including policy impetus to improve competitiveness of firms and ensure a more realistic exchange rate for the rupee. But without that recovery, a manufacturing sector revival cannot become sustainable.

In other words, there are some positive developments in certain sectors of the economy, which give rise to hopes of the economy bottoming out. But the fulfilment of these hopes will depend largely on how the government manages the economy in the coming few months and tackles the more troubling questions on reviving demand.

The Reserve Bank of India (RBI) is hopeful that the second half of 2019-20 will see better GDP growth rates than the 4.75 per cent recorded in the first half. Its projection for now is that it would hover between 4.9 per cent and 5.5 per cent. And the first half of 2020-21 may bring in higher growth rates ranging between 5.9 per cent and 6.3 per cent.

If retail inflation remains benign and within the safe zone mandated under the law (between 2 per cent and 6 per cent) and the government comes out with the necessary policy package to sustain economic growth, the RBI should be ready to step in with more easing of the monetary policy. Its latest assessment gives enough indication that it has monetary policy space for future action, which will depend on the developments in the next few months.

The ball, therefore, is truly in the finance ministry’s court now. What it unveils in the Budget for 2020-21 on February 1 will influence the way the Indian economy fares in 2020. What it does to revive demand will determine if the economy can shrug off the impact of an economic slowdown and regain fresh momentum to sustain growth. No other Budget in recent times has become so critical for the economy.