India’s economic slowdown is intensifying. GDP growth fell to 6.8 per cent in 2018-19 from 7.2 per cent in the previous 12 months, but we expect it to drop to just 4.9 per cent in the year to March 2020.

All the major surveys from India’s central bank show sentiment worsening sharply. Funding has dried, tax revenues are weak, unemployment is rising, railway and cargo traffic has declined and demand for power fell sharply.

Of about 50 activities that we track, three-quarters continued to worsen in the three months to September. Industrial production weakened substantially and industrial credit slowed further, rural and urban consumption trends were below par, and investment indicators remained particularly weak.

That said, central government started spending in earnest only from August – following national elections in May and the budget in July – and public expenditure grew by 25 per cent over the summer quarter compared with a 3.2 per cent contraction in the previous three months. Monsoon rains should also leave agricultural production in line with 2018, though real rural wages continue to slide.

Even so, annualised GDP growth in that quarter may have dipped to just 4.4 per cent. With India’s potential growth estimated at almost 6.5 per cent, this leaves a wide output gap that will depress core inflation.

Food inflation, however, exceeds 4 per cent and headline inflation is likely to remain above the country’s 4 per cent target in coming months.

The Reserve Bank of India has to focus on the sluggish momentum in core inflation rather than food spikes, though. After a quarter-point interest-rate cut in December, we now expect another reduction by March 2020, taking total cuts since January 2019 to 1.85 per cent and reducing the repo rate to a record low of 4.65 per cent.

However, cutting rates and keeping liquidity in surplus is not sufficient. Policy-rate cuts must be transmitted into the real economy, and that requires banks to take credit risk (giving out loans), term-premia risk (taking longer-term plays) and liquidity risk (also cutting deposit rates). But banks are shying away from this.

There are good reasons why. The banks’ stock of non-performing loans remains high and growth slowdown, plus exposure to non-bank finance companies, means the stock could rise higher. And specific sectors, including telecom and property companies, pose further risks to balance sheets.

The resultant slowdown in investment, real credit growth, corporate profitability and real wage growth over the last decade has produced the current slowdown. And because corporates, households and the government all entered the current slowdown with stretched balance sheets, none can spend their way out of it easily.

Growth will recover only when the balance sheets are cleaned up. We expect it to pick up gradually from mid-2020 as government moves to resolve the stress work. The 250 billion rupee fund to revive stalled housing projects is one step; the push to public-sector asset recycling is another.

Further measures could include strengthening the insolvency code, untangling stalled investment projects, and direct government intervention in key property and finance companies. Pursuing such ideas aggressively could see GDP rise 5.9 per cent in 2020-21 and 6.3 per cent the following year.  

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