The world economy continues to recover as it experiences growth acceleration for the 5th consecutive quarter. However, South Asia, which has been the powerhouse behind this recovery, lost out to East Asia and the Pacific in terms of growth rate. This brings to a halt a remarkable trend as South Asia had been the fastest-growing region in the world since Q2 of 2014, even touching a record high growth rate of 9.1% in Q1 of 2016.
One of the more surprising things is that South Asia has experienced a sharp fall in its growth rate which is now just 5.6%, compared to East Asia and the Pacific which recorded growth rates of 6% and 6.5% respectively.
So, the question arises – ‘What are the factors behind this slowdown?’
Well, to be fair, not all South Asian nations are experiencing slowdowns. The overall slowdown is driven by – India – which is the region’s powerhouse.
However, before questioning what exactly is happening in India, let’s first consider the following:
In Q1 of 2016 – India recorded growth in excess of 9%.
Q2, Q3, and Q4 of 2016 saw growth in excess of 7%.
But, ever since Q2 of 2016 – India has experienced a deceleration.
Q1 and Q2 of 2017 saw growth rates of 6.1% and 5.7% respectively; thus, causing India to lose out to China, which saw a 6.9% growth rate in Q2 of 2017, in terms of ‘the fastest growing economy in South Asia’ and ‘the fastest-growing large economy in the world’.
Now, coming back to the question of what exactly is happening in India.
Much of this economic slowdown has the following four factors to blame:
Demonetisation was the withdrawal of the currency in circulation that took place in November 2016. It has that apart from bringing the nation to an abrupt economic halt, demonetisation also disrupted supply chains in manufacturing – the impacts of which have now become evident.
2. Decline in Public Expenditure (PE) Growth Rates
Post-demonetisation PE was boosted to stimulate growth; but, by Q2 of 2017, there had been a sharp decline in PE growth rates. It that this reversal could have affected aggregate demand and hence – growth.
3. Hasty Introduction of the Goods and Services Tax (GST)
The GST to increase both efficiency and transparency, as it envelopes all indirect taxes under a single with the motive of transforming the country into a unified market. the complicated transition into the regime, owing to factors like lack of technological know-how and hastened implementation, has affected growth.
4. Private Investment and Government Spending
In Q1 of 2016, the growth of Gross Fixed Capital Formation was 9% p.a. and that of Public Consumption was 8%; however, the corresponding figures for Q1 of 2017 were (-2%) and 35%.
While imports, which had contracted by 4% p.a. in Q1 of 2016, on the other hand, saw a growth of 12% in Q1 of 2017; and it is known that lower Private Investment and higher Imports bring down the growth rate.
But, it has to be noted that India’s growth rate has actually been on the downward trend ever since Q2 of 2016 while two of the major factors blamed for the slowdown – demonetisation and the introduction of the GST – were carried out in Q4 of 2016 and Q3 of 2017, respectively. Hence, the factors mentioned above just touch the surface of the entire issue.
So, let’s broaden our view by considering certain internal constraints that might be the actual forces behind India’s ‘sustained’ economic slowdown:
1. Large Public-Sector Borrowings
The Central Government of India has shown tremendous fiscal discipline and diligence as it has managed to bring down the fiscal deficit from the heightened levels that it had attained during the stimulus policy which was implemented to reduce the effects of the worldwide crisis. But the Indian State Governments are overturning the efforts on the part of the Centre. This is especially worrying considering the increasing levels of subnational contingent liabilities, the liability of which could, sooner or later, to the Central Government.
2. High Interest Rates despite decelerated Inflation
According to the Flexible Inflation-Targeting Framework, India has adopted an inflation target of 4% with a 2% band on both sides. When India’s growth had begun decelerating in early 2016, the inflation levels exceeded the policy target substantially. But by September 2016, this was not the case anymore, rather, in many cases, inflation has been well below the policy target over the past year.
But still, the Reserve Bank of India continues to adopt a cautionary instinct as it lowered the policy rate from 6.5% to just 6% in August 2017. The Cash Reserve Ratio* and the Statutory Liquidity Ratio* have also seen drops, but the interest rates have been slow to decline – the probable cause for which is the enormous public sector borrowings highlighted earlier.
3. Stressed Banking and Financial Sectors
The process of clean-up of bank balance sheets has brought to the fore vast amounts of Non-Performing Assets (NPAs) which are still increasing in number. Combined with NPAs, overleveraged companies are negatively affecting credit growth in India.
Although there is little risk that the situation will transform into a crisis, debates regarding debt structuring, consolidation and recapitalisation of banks are bound to happen in terms of policy tweaks and intervention.
*The Cash Reserve Ratio and the Statutory Liquidity Ratio are instruments that are used by the Reserve Bank of India to influence the interest rates in the country.
Reference and Figures taken from: World Bank. 2017. “Growth out of the Blue.” South Asia Economic Focus (October), Washington, DC: World Bank. Doi: 10.1596/978-1-4648-1213-2