India has been facing a broad-based slowdown in economic growth. Private consumption in the first half of FY20 grew at a meagre 4 per cent on year-on-year basis, compared to over 8 per cent in FY17. While this is worrying, the situation has been further exacerbated by the growth in investments being projected at a meagre 1 per cent in the current year—a significant low since FY03. All eyes are now turned to the Union Budget, hoping for a much-needed fiscal nudge that can revive the Indian economy and correct its growth trajectory.
Tweak tax slabs: The anatomy of this slowdown throws up several factors. While there are deep-rooted structural reforms that need to be undertaken, the Budget should focus on providing shorter-term economic buoyancy. Reflating the economy is the need of the hour. To do so, reviving sentiment is a prerequisite.
After the cut in corporate tax rate on the supply front, the Budget could opt for cuts in income tax to tackle slow demand, strategically targeting the middle-income strata earning Rs 5-20 lakh per annum. This is also the strata where the tax slab jumps suddenly from 5 per cent for those earning below Rs 5 lakh to a steep 20 per cent for those earning between Rs 5 and 10 lakh. This will increase disposable income and translate into incremental consumption from the highest-spending strata. Going the direct tax way is critical to bring the “feel-good factor” back into the economy.
Secondly, this Budget needs to target two sectors on priority basis—real estate and credit. These are the two sectors that were critical catalysts of the economic cycle. When they dried up, the current logjam we see was created.
Realty needs a boost: The last Economic Survey highlighted that private investment is a key driver for creating a self-sustaining virtuous cycle in India. About 40 per cent of private investment comes from households, and the majority of it is for creation or repairing of dwellings. The real estate sector’s contribution to the Gross Domestic Product has fallen from around 9 per cent in FY2000-2004 to a mere around 6 per cent in the past four years—a drop of 33 per cent. Both supply and demand-side constraints prevail in the sector today. There is a dearth of liquidity and capital for builders in the post-RERA (Real Estate Regulatory Authority) world. To further add to woes, credit issues of realtors have become more pronounced after the adverse developments at IL&FS, when NBFC funding to the sector dried up completely.
On the demand side, the genuine buyer is constrained by low purchasing power and investors are dealing with a strong recency bias of no asset-price reflation. Hence, the average citizen has lost the will and the money to invest in real estate. This is one sector that will contribute significantly to the next bull phase of the Indian economy. Income tax cuts coupled with rebates on investing in property could be the key to bringing back demand. This could also stimulate asset-price reflation and mark the reversal of the real estate cycle.
TARP-like programme required: The lack of credit flow in the economy has choked its functioning. Its total credit book stands at around Rs 124 trillion, of which around Rs 97 trillion comes from banks, while the rest comes from NBFCs. Of total bank credit, 61 per cent is from public-sector banks (PSBs) and 39 per cent from private banks. The drying up of NBFC and PSB credit has impacted Rs 84 trillion of the credit book. According to Reserve Bank of India’s (RBI) annual report, the total flow of credit in the economy in the first half of FY20 was just 12 per cent of what it was in the first half of FY19. With 88 per cent of credit vanishing, economic growth and growth of large-ticket items like housing and automobiles has come to a standstill.
This slowdown, which has been driven by the current squeeze in credit, needs urgent repair. Credit spreads have been elevated owing to high risk premiums. Lenders are scared. Lending has failed to pick up despite interbank liquidity shooting up to a surplus of Rs 4 trillion. The RBI has eased rates by 135 basis points (bps), but transmission has been meagre—just 44 bps for new loans. Rates have, in fact, gone up by 2 bps for outstanding loans. Getting the flow of liquidity in the economy is the key as is getting stressed-out NBFCs back into the game. What could be most effective here is a Troubled Asset Relief Programme (TARP) like framework, as was implemented by the United States and the European Union in 2008. Providing liquidity to NBFCs with lower-rated collateral could get both sentiment and credit flowing back into the economy.
The bigger question with regards to the Budget always is: Can the fiscal afford it? The Centre’s fiscal deficit, including internal and external budgetary resources (IEBR), is hovering at around 5.5 per cent of GDP. It is high, no doubt, but the idea to go countercyclical for FY21 stays intact. The government should rationalise social-sector spending and opt for ways and means to curb leakages further. The PM KISAN amount could be made substantial, but at the same time subsuming of some subsidies should be considered. This will be more effective in boosting consumption. More importantly, it should be clear in its guidance that it aims to spend more to fix the current slowdown. A clear but higher fiscal deficit number will be perceived more positively by the markets, when compared to another year of unsure fiscals and uncertainty over expenditure.
Historically, we have seen that government expenditure drives growth recovery and leads private consumption. An expansionary fiscal policy after monetary easing could be the boat on which the Indian economy could sail through these troubled waters and chase its $5 trillion dream.
The writer is head of research, Edelweiss Wealth Management
