India’s current economic slowdown is due to a combination of two underlying factors.. First, there is the short-run cyclical slowdown showed by a number of high-frequency indicators, reflecting a significant fall in demand, especially for sectors such as automobiles, consumer durables and housing.
Second, there is the more serious long-term fall in investment and savings rates. Raising growth requires that attention be paid to both cyclical and structural dimensions of the problem.
Assuming an Incremental Capital Output Ratio (ICOR) of 4, this meant a fall of nearly 1.4% points in the potential growth rate. The fall consisted of sectoral decreases in the household, private corporate and public sectors (as indicated in the table).It is noticeable that the fall in the household sector’s investment rate got arrested by 2015-16. However, by then, the rate had already fallen by 6.3% points. From 2016-17, the sector’s investment rate even showed some recovery.
FALL IN HOUSEHOLD SAVINGS RATE
The Gross Domestic Savings Rate also fell between 2011-12 and 2017-18 by 4.1% points, from 34.6% of GDP to 30.5%. However, this fall was entirely due to the household sector, with the private corporate and public sectors showing increases in their savings rates by margins of 2.2% points and 0.2% points, respectively. Private corporate and public sectors were the deficit sectors, financing their deficits from the surplus savings of the household sector. In addition, net inflow of foreign capital added to the flow of investible resources.
Reducing the repo rate by a margin of 110 basis points in 2019 has not as yet resulted a noticeable growth . Complementary fiscal stimulus, in the form of additional public sector investment, may prove to be a viable option.
However, due to constraint in fiscal stimulus there is limited flexibility for increasing centre’s capital expenditure directly. In the 2019-20 budget, this is estimated to be 1.6% of GDP. There may be some expansion, if additional dividends from the Reserve Bank of India (RBI) flow to the government. Further, there may be some possible additional disinvestment.The way to meet slowing demand is to increase government expenditure. In the current situation, there can be an increase in government expenditure but it has to be directed towards an increase in investment expenditure.
Another area that needs immediate attention is the financial system, which must be incited to lend more.On the structural reforms that are needed to push the economy onto a sustained high growth path, much can be said. We need a re-look at the Fiscal Responsibility and Budget Management Act (FRBM) Act. The government should actually move towards reducing the revenue deficit to zero. This can happen if the Centre focusses more on items on the Union list. Once this is achieved, the Central Government can be given full freedom over fiscal deficit, as the entire deficit will be directed towards meeting capital expenditures.