The Indian election this year brought Prime Minister Narendra Modi a strong majority, and a promising platform to push through liberalizing market reforms. But “Modi mania” alone won’t stop the economy from underperforming in 2020. Indeed, with economic growth sliding to its weakest pace in six years, a prolonged slowdown is in the cards, which is likely to take the shine off the prime minister’s popularity.
Modi has so far relied on his charisma and nationalist appeal to stay on top of the opinion polls, but economic matters will increasingly be on the minds of voters. The country desperately needs to raise levels of private investment and achieve the 9-10% GDP growth required to employ the staggering 1 million entering its workforce every month. Once Modi’s Bharatiya Janata Party (BJP) is able to command both the upper and lower houses of the Indian parliament, potential legislative changes to boost labor-market flexibility and hasten infrastructure projects could bode well for turbocharging the country’s economic expansion. But in the short term, economic growth will remain sluggish – around 3 percentage points below where it needs to be.
That’s because next year, India’s credit crunch, its knock-on impact on industry, and weak demand will continue to bite. Lending growth recently dropped to its lowest level in nearly two years. That’s a trend that will likely continue into 2020, given the challenge mainstream lenders face with non-performing loans, and the compounding effect of an emerging interconnected liquidity crisis across India’s financial system. The collapse of Infrastructure Leasing & Financial Services (IL&FS), one of India’s major non-banking finance companies, has raised borrowing costs and exposed further weaknesses across the country’s shadow-banking sector. Meanwhile, with low prices already hurting incomes from agriculture, India’s biggest employer, consumer spending will be further dented by a slowdown in lending, and a dip in savings.
The wider slowdown in consumption and the financial sector will also continue to hamstring private investment in the year ahead. Reflecting this, business confidence in the country has already dipped to its lowest in six years. And the many domestic factors contributing to firms’ weaker outlooks are likely to persist into 2020. Meanwhile the synchronized global slowdown, and the US-China trade war, will put a lid on exports and add friction to Indian businesses’ cross-border supply chains. India’s automotive industry, which employs an estimated 35 million, is a particular sore point. It will continue to weaken next year, given the limited access to finance, low vehicle demand, and the broader push toward electric vehicles, which will put jobs on the line.
Policy is also playing its part in India’s slowdown. Small and medium-sized enterprises, which account for around 30% of India’s GDP, are still adjusting to major changes. Demonetization in 2016 caused severe disruption across India’s dominant informal economy, and contributed to cash-flow difficulties among many SMEs. The introduction in 2017 of the goods and services tax (GST), which replaced a range of federal and state taxes, added costs and disruption for some businesses. In the long run, these policies will help push informal economic activities into the formal tax base, yet they are still bedding into the economy, and the disruptive impact to the business community, on top of tough credit conditions, will still be felt next year.
Policymakers are not unaware of the economy’s travails. A surprise cut in the corporate tax rate to 22%, additional incentives for new manufacturing companies, and initiatives to support farming incomes were recently announced. The boosts comes alongside five interest-rate cuts by the Reserve Bank of India already this year. That may provide some uplift for the economy next year. But lower growth more generally risks pushing the government above its fiscal-deficit target of 3.3% of gross domestic product, raising government borrowing costs and lowering the likelihood of further supportive measures next year.
In the face of a stuttering economy, Modi may still bank on his popular appeal, but confidence in his government pushing for reforms has been falling. “Political confidence” in a business survey conducted by the National Council of Applied Economic Research, a think-tank, recently fell to its lowest in three years. When it comes to the economy, the BJP has often been accused of being too distracted by cultural and religious issues. That said, the public will be aware of the prime minister’s track record, and ambition, for pushing through major policy changes, successfully or otherwise. But it may soon become impatient. With a median age of around 27 years, jobs growth will be essential if the BJP and Modi are to satisfy the nation’s youth, and stay on their perch.
Next year the government will face an uphill struggle trying to overturn slowing growth and a credit crunch. It will first need to help clean up stresses in the financial sector and boost liquidity, to get consumers buying again. Efforts to jump-start private-sector investment, divest inefficient state-owned enterprises, and push through reforms that remove red tape from the jobs market and infrastructure projects should be next on the agenda. Change will depend on political will, but until then, the Indian economy will continue to fall well below its potential.