The recent economic downturn in India has been the talk of the hour. The state of Indian economy is at its worst phase since the Modi Government came back to power in 2019. Having lost its coveted title of world’s fastest growing economy to China, India’s GDP growth rate has slipped to a six year low at 5% during the April-June quarter of 2019-20, putting the Reserve Bank of India’s projected GDP growth rate of 6.9% in grave danger.

This decrease in the growth prospects of the Indian economy is largely due to the decline in manufacturing output and lack of consumption demand. This is clearly evidenced by the miserable state of Indian automobile sector, with an 18% dip in overall sales in July, 2019 alone. The worst hit was the passenger vehicles category, which saw a 35% decline in sales, followed by a decline in the sales of commercial vehicles by 25% and two-wheelers by 16%. Many automakers like Tata Motors and Ashok Leyland temporarily shut down their factories and suspended production so as to reduce excess inventories in a situation of weak demand. More than 300 dealerships have been closed and a mammoth of 230 thousand jobs have been lost in the sector. This heavy decline in sales has been caused due to a basket of factors, catalysed by upcoming changes related to environmental regulations and electric cars, and a lack of financing. India’s move to adopt new emission norms from April 1, 2020 has caused consumers to delay their consumption temporarily, partly because of the apprehension regarding validity of registration. A drop in rural demand is also evident from the reduced sale of tractors and two-wheelers in the country. In case of commercial vehicles, an increase in the freight carrying capacity of trucks has shrunk demand for new trucks. Further, an increase in the price of vehicles due to manufacturers having to comply with stringent safety regulations (airbags, anti-lock braking system and other crash norms) has weakened demand.

The government has tried to kick start the auto sector by taking steps such as lifting the ban on the purchase of vehicles by government departments, allowing additional 15% depreciation on vehicles acquired from mid-August till March 2020 to lower taxable profits and deferring the increase in one-time registration fee of vehicles until June 2020. However, many economists believe the downturn in auto sector to be cyclical caused by recent developments in the Indian economy which will eventually fade away.

The real problem comes in when people do not even have the money to buy things of everyday use like soaps, biscuits, tea, spices. The Fast Moving Consumer Goods (FMCG) market is in a lull with slowed down volume growth (number of packs sold) of companies like HUL, Daabur, Britannia during first quarter of the current financial year. On the other hand, the real estate sector is experiencing a downward trend in demand, with 1.28 million unsold houses as of March 2019, a 7% increase in the number from the previous year-end. This slowdown has affected more than 250 ancillaries that have forward and backward linkages with the housing sector, ranging from steel and cement to furnishings and paints.

The underlying cause of the poor performance of the manufacturing sector is a fall in private consumption and investment. While turbulence in the world economy has impacted India’s exports, the slump in internal demand is a result of falling rural and urban wages. From having high double digit figures, growth rates of both rural and urban areas has plunged to dismal single digit figures, largely due to structural changes like demonetisation and GST in the country as well as a poor monsoon affecting the agricultural income in rural areas. This has resulted in stagnant per capita income (in real terms) and to keep the consumption expenditure at the same level, the household savings have declined, resulting in a subsequent decline in investment.

There exists a slow growth in retail loans such as home loans, vehicle loans and personal loans granted by banks and non-banking financial companies (NBFCs) during the first quarter of 2019-20. After the DHFL and IL&FS crisis, banks and mutual funds are reluctant to lend out to these institutions. This liquidity crunch of NBFCs has decreased their lending capacity. Borrowers too are apprehensive of their ability to repay loans in a period of decreasing real income and employee layoffs. Further, an inverted yield curve in the US, a symbol of long term lending rates being less than short term rates, is taken as an indicator of impending global recession. This is because banks borrow at short term rates and lend at long-term rates and the downward sloping curve means that the loans of these banks will become unprofitable, forcing banks to reduce their lending in the market, resulting in decreased economic activity globally.

The Modi Government has been quick in initiating a recovery process to bring back the economy on track and undoing the damage done by its Budget 2019. The government recently unveiled the mega plan to merge ten public sector banks into four, reducing the number of public sector banks to merely 12 in the country, as part of plans to create fewer and stronger global-sized lenders to boost economic growth. The Union Budget 2019 also talked about injecting ₹70 trillion for recapitalisation of public sector banks to increase credit offtake in the economy. The Reserve Bank of India has also cut the repo rate for the fourth time in a row in 2019 by 35 base points to peg it at 5.4% giving commercial banks a nudge to reduce their lending rates, thus passing on the benefit to customers and attracting them to borrow more.

Another smart move off late is certainly the transfer of surplus funds of the central bank, worth ₹176 trillion to the Indian government, which will not only reduce the government’s dependence on external borrowings to finance its fiscal deficit target of 3.3%, but also increase per capita income and job creation via increased government expenditure at a time of weakening private investment. However, this transfer will reduce the wide gap between estimated revenue and expenditure by merely ₹580 billion in this fiscal year, because an amount equivalent to ₹900 billion has already been proposed by the Budget 2019 and an interim dividend worth ₹280 billion has been transferred to the government in FY19. The government has further announced the rollback of enhanced surcharge on foreign portfolio Investments (FPIs) as well as exemption to startups and investors from paying an ‘angel tax’ so as to reverse the outflow of money from the Indian stock market.

This current contraction in the Indian economy is neither wholly cyclical that is bound to eventually fade away nor is it wholly structural that will result in a massive recession. It is rather a combination of both, with lower per capita income, especially in rural areas, and low job growth being major structural issues plaguing the economy; and low consumer demand and liquidity crunch being the prime cyclical problems. The government has wisely used both monetary and fiscal measures to combat this slowdown, but there is still a lot that needs to be done like new infrastructure projects, affordable housing schemes, modified GST rates, better irrigation facilities and enhanced liquidity of NBFCs. In a time when the private sector is wary of investment, it is only the government that can nudge the economy out of the rock bottom.