Economic slowdown, 2019 – Cost of cleaning-up?

Does the 5% of today has its roots in the 10% of yesterday?

Many people are expressing concern over the slipping GDP growth numbers in recent months/ quarters. The GDP growth rate (Note: It is still growth) for the 2nd quarter of 2019 had been 5% which has been the lowest in 6 years.

The above chart plots GDP growth between 2009 and 2019. The last time it was as low as this was in 2013.

From the graph we can see the GDP growth line is, by nature, far from linear. There has been a sharp decline between 2010 and 2012 despite there not being any global slowdown influence. In comparison, in 2019, there are signs of a possible global slowdown with 5 major global economies showing a dip in manufacturing and overall growth rates. Hence, India’s dip in numbers over 2018 and 19 are not in reverse to the global sentiment.

Are there any local factors contributing to the slowdown?

Having said that, let us examine whether there are some any factors which might have influenced a slowness in Indian manufacturing and consumption. It is quite clear that in Indian manufacturing growth has not happened in recent times. The main attribute to this could be inability of the industry to invest in new projects. To invest, the promoter will have to borrow from the market (loans from banks) or raise funds through IPO. To be able to raise funds through IPO, one would rather wait for a bullish market so that the scripts can command high premium on one side and rapid growth in capitalization post listing on the other. Sadly, the stock markets have not performed expectedly in recent times especially since the announcement of additional tax on the super-rich, including the foreign investors. This tax had killed a lot of interest in the secondary market for the foreign investors (some Indian investors as well). However, while we speak, this tax has been withdrawn from foreign investors. Also, the markets have bounced back after the reduction on Corporate tax from 30% to 25.2%, but that might be temporary.

Borrowings from banks have been even more difficult in recent times as the banks have been reeling under a severe NPA situation. The NBFC route has also chocked because of IL&FS bankruptcy. With the main lenders in severe sickness, the flow of capital is completely choked down. Hence a no-growth situation.

Reasons for the 10-lakh crore NPA situation

We have to go back a few years to understand the reason. During the happy days of 2010 and 11, when the GDP growth was hovering around 10%, public sector banks made a lot of investment to many new projects. Many of these projects have nosedived into bankruptcy thus wasting all the investments made out of public money. On a closer examination, one would see a clear plan in the entire scheme of things. Banks invested money into projects without verifying their viability. The new projects produced goods and services which pushed up the GDP figures, but a majority of those goods/ services remained either unconsumed or consumed at a lower than break-even prices. As a result, the projects slipped into losses and the loans turned bad. Also, we must not forget the effect of near 10% inflation which associated with the 10% growth, but that is a different question, which will be discussed later. To summarize, it will not be unfair to say that GDP growth was effectively purchased out of an investment (or squander) of public money.

The effects of the massive NPA situation starved the banks from making further investments in the later years (and this problem continues) thus paralyzing the whole credit system. As if this was not bad enough, colossal amount of accumulated bad loans, management corruption and wrong financial reporting forced IL&FS to shut shop, thus choking the NBFC credit route as well.

Because of the mounting bad loans (and the eventual accountability falling upon them) the banks eventually lost trust in a certain section of entrepreneurs. The trust factor between the lenders and the entrepreneurs is probably at an all-time low now.

A chart on the rise of NPA in India can be found at: https://www.prsindia.org/theprsblog/rise-non-performing-assets-india

Here is the list of 12 companies constituting 25% of total NPAs: https://www.financialexpress.com/industry/banking-finance/indias-bad-loans-here-is-the-list-of-12-companies-constituting-25-of-total-npa/903396/

Cleaning up NPA - Insolvency and Bankruptcy Code

Forbes India, on 1st Oct, 2018, writes, “According to statistics, India is ranked 103 in the World Bank’s rankings of how nations handle insolvencies. Before the introduction of IBC, it took companies about four to five years to dissolve its operations; the number has dropped drastically to a year. This has not only increased the ease of doing business but also imbibed a stronger sense of trust in lenders and investors.”

http://www.forbesindia.com/blog/economy-policy/insolvency-and-bankruptcy-code-whats-all-the-noise-about/

Economic viability of projects and alleged Tax terrorism

IBC, coupled with increased scrutiny of the declared and undeclared wealth of the promoters led to a fear psychosis among those who did business in a certain style until that time. Though there are contradictory views on the possible reasons for the suicide of noted businessman and CCD founder V.G. Siddhartha, the fact that the Income tax department had issued him several notices to explain large sums of unexplained income cannot be ignored. According to some media sources some of his companies were shell companies with zero employees reporting huge losses. Also, a debt-trap in form of private equity investors who wants to be treated as debt-holders didn’t help the cause. Moreover, often the sheen and shine of a brand or product puts the necessary question of economic viability of the project in the back burner. The income tax department may have overdone its brief, but the fact exposed the darker side, also vulnerabilities of a regular Indian entrepreneur (especially start-ups).

Does the nation need a new breed of entrepreneurs?

Some of the dynastic entrepreneurs have been repeat offenders in the NPA space. The old methods of doing business at the risk of public money while protecting personal wealth had painted them in a poor light adding to already existing trust deficit in the eyes of lenders. To bring about a new dawn in the system, a new breed of start-up entrepreneurs may be required who will come with a clean slate (and no family baggage). The new generation needs to start with a modern mindset of transparency and accountability. Besides that, the older generations do not seem to be equipped and agile enough to meet the challenges to business models in the internet age. However, to avoid a CCD like situation, they must be very sure of the business model and sustainable bottom-line projects (mere top-line projections are not sufficient)

Is the overall consumer demand low?

GST collection figures and its trend over the last one year does not indicate any significant slowness in the overall demand situation though the collections have been mostly lower than the monthly target of 1.06 lakh crores though not by miles. Even in the month of Aug, 2019 the collection has been 98 lakh crores (92.5% of the target of 1.06 lakh crores).

The figures don’t indicate a massive slowdown in overall demand situation, though some analysists claim it is because of increased compliance (calculated on number of returns filed) rather than a tight demand situation. However, if the financial results for Q2, 2019 of major corporates are studied, no particular trend emerges except for in the real estate and automobile sectors.

Some figures indicating a rural slowness in FMCG growth in certain states but those likely to be due to temporary reasons like untimely rain impacting crops rather than any real macro-economic reason of concern. While Britannia has slowed down by 4%, Amul has grown by 14% within the same timeframe. Thus, no conclusive inference could be drawn.

Source: http://gst.indiatyping.com/gst-collection-monthly

Consumer demand vis-a-vis unemployment

Consumer demand can be affected if there is rampant unemployment as that will reduce the amount of money available for spend. Labour ministry data published in May, 2019 suggests unemployment rate in 2017-18 was at 6.1% (which was, according to some, a 45-year high). The Statistics Secretary rejected the comparison citing a new design and a new matrix used in the present calculation which was incomparable with any past data.

I used a funny yardstick to judge the real unemployment situation in the country. If we read literature or watch (even mainstream) movies of early 70s, we will find rampant references to the distressed unemployment situation in the country (a popular example is ‘Deewar’). But, in 2019, none such thing could be noted, also no real political or social unrest is observed on the ground. Hence, my conclusion would be any blunt comparison of percentages would be unfair. The current unemployment is more of, what I would call, an “Aspirational Unemployment” rather than a real unemployment.

Aspirational employment happens when somebody is made to perform a role which is beneath his justified aspirational levels because of lack of adequate opportunity. Personal aspiration can vary from person to person, hence it needs to be justified measured on certain yardstick of education, skill and experience.

Source: https://www.thehindu.com/business/Economy/unemployment-rate-at-45-year-high-confirms-labour-ministry-data/article27379174.ece

While the population is getting more educated, it is also becoming more aspirational, though the traditional education (even higher education) may not be able to produce a workforce which is fit for the changing market. Technology and automation will eat away conventional jobs while creating new ones in the process. Skilling and re-skilling, therefore, becomes the most essential factor to bridge the demand-supply situation of the market vis-à-vis the population.

Also, the nation may not be able to provide employment to a rapidly growing population in the days to come, which makes it evident that population control will become key to the unemployment woos of the future. Fortunately, except for a few North Indian states the population has shown signs of growth decrease taking the overall growth rate very close to the ‘sustain’ figure of 2.1

Source: https://timesofindia.indiatimes.com/india/how-worried-should-we-be-about-indias-population-explosion/articleshow/70711314.cms

What’s exceptional about the real estate and automobile sectors?

A slump in the real estate sector has seen 3.7 lakh units of unsold stock in Mumbai alone (as on Aug, 2019). Unsold stock would mean blocked funds which would prevent new investments kicking-off new projects. A definite fallout of that is the massive unemployment that has hit the sector.

Source: https://www.indiatoday.in/business/story/slump-in-real-estate-sector-hits-mumbai-hard-1590970-2019-08-23

Though, interestingly, demand for commercial premises has defied the slowdown trend and have risen in recent months.

Source: https://www.livemint.com/news/india/office-real-estate-is-defying-the-slowdown-1566745289885.html

Similarly, in the automobile sector, sales of passenger vehicles had fallen by 30.9% between July, 2018 and July, 2019. Similar trend could be seen in the two-wheeler and commercial vehicle segments as well.

However, the Bharat Stage 6 Baleno from Maruti has shown record sales during the same time. Which goes to prove that one major factor of the auto problem is the industry’s delay in adopting to new technology and/ or compliance.

Source: https://www.businesstoday.in/markets/company-stock/auto-sector-slowdown-tata-motors-share-price-maruti-suzuki-mahindra/story/373898.html

Both the real-estate and automobile sectors have slowed due to weak consumer demand. In case of the real estate, a Reuters poll conducted in Nov, 2018 suggests “Analysts also suggest that most of the property markets in India are overvalued which shuts new buyers from entering the market.”

Source: https://www.makaan.com/iq/news-views/housing-prices-to-fall-in-2019-reuters-poll

The slowdown in demand could very well be an opportunity to rationalize the price points though the developers may want to hold rather than offer deep discounts as that might permanently damage their traditional pricing model.

Also, those who counted the failures of the demonetization decision could take a look at the vanishing black money from the system which has a big contribution in the real estate demand slump. A common perception is that even those who has been ale to hold on to their undisclosed wealth (through a 15-25% brokerage deals to intermediaries and/ or through collusion with banks) are scared to spend the money lest income tax people would be watching. It goes beyond saying that real estate has traditionally been one of the recognized factories of black money generation.

The same reason applies to the automobile sector as well (especially in the rural market) where most transactions happen in cash (and not fancy car loans, though the NBFC crisis is counted as a contributor in the urban/ semi-urban markets). To make matters worse, emerging business models of radio taxi, new pollution norms (Bharat stage 6) and the electric car technology knocking at the door has made the car buyers rethink their choice of product and timing.

Automobile industry is a classical example where traditional manufacturers are likely to face extinction if they delay any in meeting the business model challenge of the internet generation.

Before we end this section, we must touch upon the point of how the vanishing black money had also created working capital challenges for small and medium businesses during the demonetization days. Fortunately, number of permanent shut downs has been negligible.

Why the slowdown is still not pinching?

Slowdown in the construction sector (and now in the automobile sector) has caused good amount of unemployment though that did not affect adversely the overall demand situation in the country. Few reasons why the unemployment is not pinching the rural (unskilled) population are three-fold.

Firstly, the inflation management over the last five years have been exemplary. A firm control over food price rise has given a lot of comfort to the household budget, as a result even if the earnings hadn’t increased, the expenditure didn’t either.

Secondly, the spent on NAREGA has virtually doubled from Rs 33,000 crores in 2013-14 to Rs 68,000 crores in 2017-18, thus covering many more man-days besides blocking leakages through Aadhaar-linked payment.

Source: https://economictimes.indiatimes.com/news/economy/policy/rural-jobs-in-jaitley-years-how-modi-fine-tuned-mgnrega-and-made-it-better/articleshow/70020138.cms?from=mdr

Thirdly, between 2015 and 2019 (March), Mudra Yojana disbursed loans worth Rs 9.5 lakh crores to 20 crore small and marginal business who wouldn't otherwise get loans from banks due to lack of co-lateral or other security.

Source: https://www.mudra.org.in/

Will Blockchain be the big push towards a fully formalized economy?

The consorted effort to clean up the system that started with demonetization, GST, Aadhaar liked payments, anonymous tax assessments and many more of such steps is likely to receive a big push when Blockchain will be used as an e-governance measure. Land records, collective farming, infrastructure projects, education quality – the potential of using Blockchain for transparency, efficiency and fraud management is immense. That is what will leave no room for a return to the good old opaque system of fraud and scams.

The following article talks about a blockchain based voting system among other possibilities:

https://www.blockchain-council.org/blockchain/how-can-blockchain-reduce-corruption/

Conclusion:

The slowdown is in many ways influenced by the massive clean-up exercise that is currently underway. The slowdown, like any slowdown, may cause a lot of difficulties, but will finally make India emerge as one of the strongest and biggest formal economies of the world. With a 5 trillion target to achieve, an upswing could just be around the corner.