Macro Matters | Does the growth slowdown have a structural tilt? The jury is out.

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Businesses are discouraged from investing when demand is tepid. We need to watch out for the precursors of a permanent lowering of income expectations by consumers. It is time to shine the spotlight on the structural aspects of the slowdown.

 

The 5.8 percent GDP outturn in January-March 2019 was largely attributed to election-related spending restraint by the government, uncertainties and liquidity squeeze caused by the NBFC crisis.

Post-election, an upturn in the economic cycle was commonly anticipated. Does recent economic performance match up to these expectations? So far, there is no indication of an inflection in the growth trajectory although less than half the April-June quarter falls into the post-election zone.

Nearly every indicator points to a continued slowdown, including last month. This wouldn’t be so bad if outlook and sentiment were upbeat. But the fact is that these too remain subdued. This raises questions about the nature of the slowdown – is it structural rather than cyclical?

On the consumption side, auto sales’ contraction deepened more severely in April-June, spread across cars, two-wheelers, tractors and commercial vehicles. Fresh plant shutdowns have recently emerged adding to past production cuts by auto manufacturers.

The impasse in the housing and larger realty segment continues; housing prices are either stable or lower in some cities while the RBI’s all-India housing price index showed steady sequential and annual deceleration up to the December 2018 quarter. Volume growth of FMCG companies slowed with rural sales converging with that of urban areas in a marked deviation from the past growth trend (1.5 times that urban sales).

Industrial output corresponds to sales trends: consumer durables’ output maintained its deceleration, shrinking in May (year-on-year, three-month moving average); non-durables looked up a tad. In June, stagnant sales pushed the services PMI into negative zone for the first time since May 2018; the manufacturing PMI moderated from tapering domestic and external demand.

Exports and imports grew a respective 3.14 percent and 3.57 percent in the quarter compared to a corresponding 14.3 percent and 12.2 percent last year; non-oil, non-gem & jewellery exports shrunk 5 percent in June while non-oil imports fell 7.3 percent.

Signals on investment are equally uninspiring. First, CMIE’s investment project-tracking data show new investment proposals fell steeply in April-June– these were just 12.6 percent of the value in the same quarter last year, and 17 percent of the average new investment proposals in preceding four quarters. Then, capital goods’ output rose an average 1 percent in April-May. Public capex picked up relative to the March 2019 quarter, but only slightly.

Overall, there is ample evidence of low demand, within and outside. With global growth pulled down by trade tensions and tariff wars, domestic demand matters assume greater significance at this juncture. And on this, the prognosis is not good. Consider that several corporate heads judge the worst isn’t over yet; some have expressed bewilderment about the slowdown, describing it peculiar or inexplicable, not entirely explained by the liquidity shock (NBFC lending squeeze) or cyclical factors such as elections, and more associated with consumer sentiment. Business sentiment also plunged to its lowest in 3 years this June, shows IHS Markit’s Global Business Outlook survey.

By far the most telling evidence comes from the remarkable fall in core inflation, a measure of demand in the economy. Core retail inflation has fallen 220 basis points in just a year; at the wholesale level, core inflation has plunged 392 basis points!

This shows producers are operating in an environment of incessantly weakening consumer demand and unable to pass on higher costs. Decelerating incomes, especially from prolonged low food inflation, raise the spectre of consumers adjusting to lower anticipated incomes on a more enduring basis.

If that is indeed transpiring, then a structural dimension to the growth slowdown cannot be ruled out. At present, there is insufficient information to confirm if such a process is playing out. The first signs of spending adjustments by consumers in response to fall in incomes – lower discretionary spending – are sufficiently manifest in sustained decline of durable goods’ output, inventory pile-up in auto sector and housing, etc.

Their perseverance for almost one year has dragged down production in turn. Producers and businesses are discouraged from investing on their part when demand is tepid and returns are poor. What needs watching out for is the precursors of a permanent lowering of income expectations by consumers. It is time to shine the spotlight on the structural aspects of the slowdown.

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