Last year, markets were cheered as the Indian economy receive a massive fiscal and monetary policy stimulus. Despite this, the Indian economy has been on a weak growth path – GDP growth slumped to more than a six-year low of 4.5 per cent year-on-year in the third quarter of 2019.

In addition to this, monthly economic indicators showed no sign of improvement. The most significant indicator being the infrastructure industry output index, which posted its worst drop in October and continued into negative territory in November. This index serves as a good guide for GDP growth because it measures the aggregate output of key infrastructure sectors such as coal, crude oil, natural gas, petroleum refinery products and so on. 

The main factor that has caused this drag on GDP growth is weak domestic demand which averages around 4.8 per cent – a significant drop from the 6.8 per cent in 2018.

The contribution of private consumption and the fixed capital formation contribution dropped sharply to GDP growth. This indicated that the Reserve Bank of India’s hasty easing was of no use in stimulating lending and investment. That said, a slightly better contribution from government consumption may reflect some fiscal efforts. Finally, mirroring weak domestic demand was a positive swing in the net trade contribution after two negative years.

On the supply side, the weakness was spread across all key industrial sectors – mining, manufacturing, utilities, and construction, while the growth of agriculture and services sectors has been steady so far in the current fiscal year compared to last.

The continuation of India’s aggressive fiscal stimulus means another year of overshooting the fiscal deficit. The official projection for the deficit to reach 3.3 per cent of GDP this year is way too optimistic. 

There is also no clarity about how the government will be financing this wide deficit. The $24 billion windfall from the Reserve Bank of India (RBI) won't be enough to fill the gap nor can the government continue to rely on such monetisation of the deficit forever. Tapping international debt amid an uncertain market and Moody’s downgrade of India’s BBB rating outlook has dented foreign investor confidence. This, in turn, means a greater strain on domestic debt markets, where excessive government borrowing is crowding out private investment – another indication for weak GDP growth ahead.

Weak monetary policy transmission has also been seen as a key issue for the economy and financial system. As the RBI's latest policy statement pointed out, against a total 135bp of policy rate cuts this year, the marginal cost of fund-based lending rate declined by only 49bp, and the weighted average lending rate on fresh rupee loans of commercial banks was down by just 44bp.

Failure of all the stimulus to jumpstart the economy suggests this is not just a cyclical slump but rather structural elements are playing their part too.
Among other obstacles for the economy reaching its growth potential are poor infrastructure, long delays and cost overruns in new infrastructure projects, and difficulties in utilising private investment in this sector. 

According to the Finance Ministry's Economic Survey for FY2018, the economy needs around $200 billion in infrastructure investment annually, whereas India has only been able to gather just over half of that. Tight public finances entail a greater dependence on the flow of private capital to fill the gap.

Further adding to these structural troubles, are weak public finances and high public sector debt, crowding out private investment, weak labour laws hindering private sector and foreign investment flows, high unemployment and relatively high income-tax rates depressing consumer spending.

It is clear that without significant reforms in these areas, Prime Minister Narendra Modi's vision of improving India to a $5 trillion economy in his second term will likely remain an aloof reality. That said, his latest privatisation push to sell the stakes in two state-owned companies, in the oil refining and shipping sectors, as well as reducing holdings below 51 per cent in some other public sector companies, is a move in the right direction. 

On a conclusive note, hope rests on the upcoming FY 2020 Budget on February 1. Hopefully, Modi’s way forward will be building on these initiatives as well as setting out concrete blocks toward the employment of the recently announced five-year infrastructure investment plan.

This article was issued by Maria Fenech, credit analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.