CIRCUIT BREAKER. Why the economy is lacking josh

After a new round of revisions, the CSO recently declared that India’s GDP growth averaged 7.6 per cent in the last five years, doing much better than the 6.7 per cent expansion in the preceding five years. But this bit of good news was met with a huge yawn of indifference by the citizenry. One can’t blame them.

Lately, there’s been a marked lack of the josh in the economy, that usually accompanies such GDP growth numbers. When India reported 7-8 per cent growth (according to the new back-series) in 2006-07 or 2010-11, consumer confidence was high, India Inc’s profits were growing in double-digits and the farm economy was in a happier place. Sceptics of the new GDP series attribute this disconnect to flaws in the CSO’s GDP measurement.

But there’s another possible explanation too. That India’s subdued nominal GDP growth in the last five years is hurting consumers, borrowers and India Inc.

Nominal growth hiccups

Economists like to measure a country’s achievements in terms of real output and dismiss price increases as artificial props to growth. But for most ordinary folk, nominal growth matters more, as income and wealth are their yardsticks of prosperity.

On this count, with India’s consumer inflation rate halving in the last five years, nominal GDP growth has sharply moderated. Between FY10 and FY14, averaging 15.3 per cent, India’s nominal GDP growth had even shot up to 19.9 per cent in FY11. But in the last five years to FY19, it has averaged just 11.2 per cent, never managing to top 13 per cent.

There are four ways in which subdued nominal GDP growth has proved to be a wet blanket for the economy.

Lower wage growth

Plenty has already been said about how falling food prices have pruned agricultural income and put marginal farmers on the road to penury. But industrial and service workers have taken their share of pay hits too, thanks to falling inflation.

Tracing the employee expenses for the 1400 NSE-listed companies provides evidence of this. During the boom years from FY04 to FY08, their aggregate wage bill galloped at over 20 per cent a year.

Between FY10 and FY14, as inflation remained high, it still increased at 14 per cent a year. But in the last four years (until FY18) the growth in employee expenses was just 8.8 per cent a year.

Now, 8.8 per cent may still look like a decent enough increase, at a 4-5 per cent inflation rate. But then, one needs to remember that the increase in aggregate wage bill for firms captures both new additions to the workforce and pay increases to existing employees.

Assuming that half the increase in India Inc’s wage bill was due to new hires, employees have, in effect, had to make do with pay increases of 4-5 per cent in the last five years, compared to the 10-12 per cent earlier. While listed companies represent only a section of the economy, it is unlikely that smaller firms handed out higher pay hikes than the leading lights of the economy. This slowdown in pay increases in the formal sector, coming on top of deflating farm income, is bound to have a dampening effect on consumer sentiment.

Squeezing retail borrowers

High inflation inflicts pain on savers and consumers, but benefits borrowers by making their debt look less burdensome over time. Therefore, India’s high-inflation spell until FY14 had convinced many retail folks that even if they stretched their finances to take on home, car or personal loans, those EMIs would turn quite manageable over time, with hefty pay increases.

RBI data show that between FY14 and FY19, consumers were on a loan-taking binge, with outstanding retail loans for banks more than doubling from ₹10 lakh crore to over ₹21 lakh crore.

But lately, these loan-takers have had to face the double-whammy of slower pay growth, co-existing with stubbornly high interest rates. This is another contributor to flagging consumer sentiment.

Nominal GDP growth has a direct bearing on India Inc’s ability to expand its top-line. In the heyday of FY04-FY07, net sales for the NSE-listed companies grew at over 20 per cent year after year.

After the jolt from the global financial crisis, this slowed to 13.5 per cent in FY10-FY14. But the last four years have seen India Inc really struggle to expand its sales, with growth averaging barely 3 per cent.

The last three quarters of FY19 have brought signs of revival, with sales growth returning to the double-digits. But profit growth has remained elusive as companies have found it difficult to pass on raw material increases to their customers.

Historically, listed companies in India enjoyed considerable pricing power, but the low nominal growth seems to have upset that dynamic.

The lack of a credible turnaround in corporate profits has made investors wary of high stock valuations in the ongoing bull market. It has also held back India Inc from announcing new investment plans. This has contributed to the stock market’s sideways crawl, after the big bull phase from 2012 to 2017.

When the private sector is in no mood to invest, governments in usually pick up the slack by splurging on welfare schemes and infrastructure projects.

But in stepping up public spending, the Indian government also needs to make sure that its fiscal deficit doesn’t overshoot the red line drawn by the FRBM rules.

Given that FRBM rules peg the fiscal deficit at 3 per cent of nominal GDP, the size and growth of nominal GDP sets boundaries to how much the government can spend to revive the economy’s animal spirits.

Between FY09 and FY14, India’s fiscal deficit in absolute terms galloped by 49 per cent, from ₹3.36 lakh crore to ₹5.02 lakh crore (Budget actuals). But fiscal deficit as a proportion of GDP fell from 6.1 to 4.5 per cent, a good 1.6 percentage point reduction. Deficit reduction got a leg-up from the brisk growth in nominal GDP which more than doubled in this period.

Between FY15 and FY19 though, the absolute deficit has grown at a far slower pace of 24 per cent (₹5.1 lakh crore to ₹6.34 lakh crore). But deficit reduction has proved an uphill task, with fiscal deficit as a proportion of GDP falling by just 0.8 percentage points, from 4.1 to 3.4 per cent.

The lack of nominal GDP growth, which expanded by just 50 per cent in the last five years, has been the key villain of the piece.

Overall, it is time policymakers at the Centre and the RBI realised that too little inflation, in the Indian context, can be as bad for the economy as runaway inflation. Instead of over-zealous one-way efforts to cool inflation, they need to reorient their policy-making to ensure that consumer price inflation stays in a moderate zone (say, 5-6 per cent) that is neither too hot to singe consumers, nor too cold to freeze income and investing.

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