It is now beyond doubt that the Indian economy is experiencing a steep slowdown. Every relevant indicator is pointing southwards, to the point that some market analysts like Goldman Sachs have declared that the current economic crisis is worse than 2008. The GDP data point to a clear slackening of pace, and even these data are questioned for several reasons, with many economists pointing out that—because they do not properly incorporate informal economic activity that has been badly hit in recent times—the actual rate of economic growth could be even lower.

This is reflected in how different sectors are doing. The automobile industry, seen as a bellwether of activity in the post-liberalisation years, is in crisis, as automakers, parts manufacturers and dealers have laid off at least 3,50,000 workers since April, with more job cuts likely. Cars, buses trucks, and even two-wheelers, all show declining sales. Air traffic passenger numbers are down as well. Capacity utilisation in all manufacturing is apparently below 70 per cent on average, even as inventories pile up. Rail freight traffic, an indicator of national sales, is now below the past five years’ average. The real estate and construction sectors are in a state of deep gloom. Real estate is now stuck with more than seven years’ stock of unsold buildings.

While some of this could still reflect falling demand only from higher income groups, items consumed by the less well-off also indicate worsening material conditions. Sales in the fast-moving consumer goods (FMCG) sector have been slowing down for more than a year, and the latest quarter indicates the worst performance in seven years, led by declines in rural demand. The slowdown in sales is across food and non-food items. The biggest reductions are in salty snacks and biscuits, spices, soaps and packaged tea. Recently, Parle Products, once the world’s largest selling biscuit brand, announced that it may have to lay off up to 10,000 workers (around one-tenth of its workforce).

The slowdown in mass consumption demand, combined with falling and then subdued rates of investment over several years, have together created a major crisis of inadequate demand in the economy.

These represent the more discretionary element of consumer spending even among the poor—the items more likely to be cut down when household budgets are under strain. What is more, even the infamous underwear index—that posits that the sale of men’s underwear falls in recessions—is pointing to a recession, with a sharp fall in such sales in the June quarter.  

Representatives of the Modi government, who have belatedly but finally recognised there is a problem, have blamed the current situation on the previous government, under which in fact economic activity was much more robust. They point to the “financial stress” inherited from the UPA government more than five years ago, which is apparently preventing investment because “no one trusts anyone else”.

But this isolates only one factor in the current slowdown: the undoubted mess in the credit system, reflecting both the overhang of bad debts of banks and the erosion of non-bank lenders in the past couple of years. In any case it should be noted that the sheer quantity of bad loans in the banking system has increased by more than three times after 2014, so the present government has not only been unable to clean up the mess but has also added to it significantly.

The mess in the non-banking sector that used to provide credit to the MSME is almost entirely of this government’s making. After demonetisation banks were in no position to provide credit, so shadow banking lenders like Infrastructure Leasing and Financial Services Ltd (IL&FS) were allowed and even encouraged to lend freely and without due diligence. The spectacular near-collapse of IL&FS caused such lending to freeze up as well. Meanwhile, even co-operative banks are now suspect, as the ongoing troubles in the Mumbai-based PMC Co-operative Bank have destroyed the trust of depositors. So banks and non-bank lenders are both increasingly unable or reluctant to lend and finance has become scarce especially for micro, small and medium enterprises. Even those who are willing to borrow are unable to access the required funds.

This means that the problems of insufficient credit provision are a factor—but they are by no means the only or even the most significant factor in the current slowdown. In fact, this explanation completely misses the demand side of the story. It is clear beyond doubt now that the slowdown in mass consumption demand, combined with falling and then subdued rates of investment over several years, have together created a major crisis of inadequate demand in the economy.

The boom did not generate the expected increase in quality employment: formal jobs barely increased and informal work grew at  around 2 per cent per annum even as the potential labour force expanded much faster.

How did this state of affairs come to pass? Some of this is recent, but there is a medium-term story that must be kept in mind. The economic strategy of the past two decades essentially relied on large corporate investment for greater growth, productivity, and formal sector jobs. At least that was the goal. In pursuit of this goal, it was believed that the large private corporate sector needs to be incentivised in every possible way: through access to relatively cheap credit (much of which has not been repaid), provision of subsidised inputs, amenities, land, natural resources—and of course, cheap labour. It also meant that banks were encouraged to lend more, which they did in the state of euphoria that is common in a boom. State-owned commercial banks were actually pushed into risky lending for long-term investments, something commercial banks are not really supposed to do.

This strategy worked for a while, especially during the boom of the 2000s, when GDP grew rapidly and investment rates picked up, pushing growth up further. The economic boom of the decade 2003 to 2012 was one in which even the global financial crisis caused only a temporary blip. It created a complacent belief that this trajectory could run for ever. But there were many consequences of this particular path: massive environmental damage, growing bad loans with banks, rising inequality and a proliferation of “scams” that were the by-product of all these incentives being offered to big capitalists. Also, the boom did not generate the expected increase in good-quality employment: formal jobs barely increased and even informal work grew at a measly rate of around 2 per cent per annum even as the potential labour force expanded much faster. While real wages did increase until 2011-12, the share of wages in total national income fell.

The strategy to deliver more profit to corporates by suppressing wages has reduced potential profit by shrinking the potential market. The focus on large companies left out MSMEs that provide the bulk of employment.

What is more, the boom was bound to come to an end, although not necessarily lead to the sort of crisis we are seeing today. The process of incentivising big capital cannot continue beyond a point. It has now run its course and both corporate India and foreign investors are no longer showing the same appetite for increasing real investment. Since 2011-12 the share of gross fixed capital formation (or investment) to national income has fallen significantly, by nearly 6 percentage points of GDP estimated at current prices, from more than 34 per cent to around 28 per cent now. In recent years even absolute investment has been falling.

There are many reasons for this decline in investment rates, including the weight of the bad loans in the banking system, projects held up or delayed because of environmental and legal concerns, and so on. But a very big reason is the fact that the domestic market is not growing sufficiently for a range of consumer goods because wage incomes have been suppressed. It is ironic—but predictable—that the strategy to deliver more profits to corporates by suppressing wages has ended up reducing potential profits by shrinking the potential market. The focus on large companies also left out the micro, small and medium enterprises (MSMEs) that provide the bulk of employment in the country, which have also suffered the most from policies like demonetisation and the poorly implemented GST. That decline in investment, especially by MSMEs, is also a big reason why employment is simply not growing fast enough to meet the needs of the young educated population, and why it is so hard for them to find jobs that meet their aspirations. 

Demonetisation fulfilled none of its stated objectives, but did succeed in creating an unholy mess in the economy, beginning with the complete collapse of transactions that kept the informal sector activity running.

All these indicators point to one overwhelming reality: there is a genuine slump in aggregate demand, driven by slow and now declining consumption. Consumption data that can be gleaned from the latest Labour Force Survey show an alarming picture. For the first time since such data began to be collected, average consumption expenditure declined in real terms in both urban and rural areas between 2014 and 2017-18. In rural areas it declined from ₹1,587 per person per month in 2014 to ₹1,524, and in urban areas from  ₹2,926 per person per month ₹2,909. After 2015-16, real per capita consumption spending has declined at an annual rate of 4.4 per cent in rural areas and 4.8 per cent in urban areas. This is extraordinary for an economy that was ostensibly growing at 6-7 per cent in the aggregate.

In any normal economy this would be unthinkable—but India was not a normal economy in this period. The disastrous demonetisation of November 8, 2016, fulfilled none of its stated objectives, but did succeed in creating an unholy mess in the economy, beginning with the complete collapse of transactions that kept the informal sector activity running. The informal sector accounts for more than 85 per cent of workers in the economy, and before demonetisation it was estimated that around 98 per cent of all transactions were in cash. Denying cash without providing adequate replacement of liquidity or means of transacting basically brought a lot of activity to a standstill, and as a result many people lost jobs, livelihoods and incomes. (It also increased inequality, as the rich escaped unscathed through this process, happily exchanging their earlier notes without too much loss, while the poor suffered disproportionately.) These effects were not just temporary—they broke up supply chains, had adverse multiplier effects over time and had repercussions on demand that persist to this day.

The collapse had both direct and indirect effects on farmers. First, they were hit immediately by the loss of access to cash at the crucial end-of-kharif harvest season and beginning-of-rabi sowing season, when cash requirements are greatest. They were then indirectly affected because of the prolonged collapse in rural livelihoods and demand, as people did not have sufficient income to demand more of their output. To add to their troubles, even crops covered under the public procurement policy did not provide sufficient income to farmers. Despite the talk of doubling farmers’ incomes, the Modi government’s Minimum Support Prices give significantly lower margins over costs for most crops than under the UPA regime. So agriculture—which remains the mainstay of rural India—has been providing low or negative growth impulses for some time now.

Low investment, employment declines and real wage stagnation lower  demand, which depresses profit expectations. So investment falls further, as investors decide to wait and see  until they can be sure.

Demonetisation also affected urban informal activities, to the point where in many areas money wages for casual labourers are now lower than they were in 2016. The damage wrought by demonetisation was aggravated by the poor implementation of a badly designed system of Goods and Services Tax barely seven months later.

These badly managed policy measures were body blows to informal economic activity, causing major declines in employment and output. At first, they did not affect formal enterprises so much, as they gained at the cost of informal ones. But the resulting loss in livelihoods and wage incomes eventually had an effect on demand for formal sector output, which has worsened over time because there have been no counterbalancing moves by the government. Total employment declined by more than 9 million workers in the period between 2011-12 and 2017-18, even as open unemployment rates reached their highest levels in nearly half a century. 

This operated in addition to a medium-term trend of wage suppression, something that was even celebrated by the late former Finance Minister Arun Jaitley as a means of combating inflation. Rural wages have been stagnant or declining in the recent period. Meanwhile the continuing crisis of cultivation has obviously affected the purchasing power of the farming community. Urban wage incomes are also apparently not keeping pace with inflation, even as informal activity and start-ups in urban areas have faltered.

The government could have countered this combination of declining employment and consumption demand (which in turn reduced the profit expectations of producers in formal enterprises) by providing a fiscal stimulus. It did not do so. Instead it kept assuming or hoping that using optical measures (like manipulating “Ease of Doing Business” indicators and offering further incentives to foreign capital to attract inflows, however volatile) would somehow attract investment into the economy that would counteract all the negative impulses.

Private investors simply kept demanding more fiscal and regulatory concessions, even as they continued to sit on investment plans as they waited for overall demand improvement. More recent complaints of the private corporate sector have been about oppressive tax collection methods of a government desperate to meet its revenue targets. But these—along with greater difficulties in accessing loans from banks and non-banking institutions—are irritants that would have been tolerated in a buoyant economy. They have become issues now because the wider economy is stagnating or even declining.

It is easy to see how this can become a downward spiral—which is what is happening. Low investment, employment declines and real wage stagnation further lower consumption demand, which reduces capacity utilisation and depresses profit expectations. So investment falls further, as investors decide to wait and see or hold back until they can be sure that they will be able to sell their output.

All this has also been associated with a complete mess being made of public finances. The poorly implemented Goods and Services Tax managed to create big problems for enterprises but still delivered revenues well below projections. This led to a gaping hole in central government tax receipts. Tax revenues retained by the Centre were lower than the “Revised Estimates” by a whopping ₹1,65,176 crore, or as much as 13.5 per cent of the revised estimates of total tax revenues. The fudge has still not been adequately explained by the finance ministry, nor have final actual budgetary numbers been publicly released, but what is clear is that the public finances of the country reflect the broader economic mismanagement. In this context, the RBI’s decision to provide ₹1.76 lakh crore of its surplus reserves could simply help the government to save face and meet its budgetary targets, rather than enabling any real new fiscal stimulus.

As it wastes its energies blaming its predecessors, it flails around with various strategies that will clearly not work.

Obviously, to revive investment it is necessary to revive demand, especially by putting cash in the hands of the poor. It is well known that public investment has a strong positive effect on private investment, through its linkage effects and because it can provide much-needed infrastructure. This is particularly true for SMEs, who would also benefit greatly from a package providing access to credit, input and markets. So the solution is in the government’s hands, if it would only recognise this. 

If it did recognise the problem, it would implement immediate measures to revive demand, for example, by expanding the rural employment guarantee programme and increasing social spending in urban and rural areas, both of which lead to direct increases in consumption and have significant multiplier effects. It could also put in place an urban employment programme that would be a buffer for unemployment and increase the welfare of urban dwellers through various social services.

These effects would generate more employment, incomes, consumption and therefore investment over time—as well as more tax revenue for the government. A government thinking ahead would also consider ways to increase public investment in green areas that will be essential for future growth, to cope with environmental destruction and growing hazards of climate change that are already upon us, by raising taxes on multinational corporations that currently manage to avoid them and taxing the very rich.

Sadly, the government does not seem to be thinking along any of these lines. As it wastes its energies blaming its predecessors, it flails around with various strategies that will clearly not work.