India Needs To Slow Down Consumption For Long Term Growth, Argues Nikhil Gupta, Chief Economist At Motilal Oswal Financial Services
Buoyed by the recent GDP growth of 7.8 per cent in the first quarter, the Indian government has set its sight on the goal to make India the third largest economy by FY28. As the country aims to sustain momentum in the economy, Motilal Oswal Financial Services Chief Economist Nikhil Gupta highlights the key challenges the policymakers need to address in his new book, ‘The Eight Per Cent Solution: A Strategy For India’s Growth’.
In an exclusive interview with Outlook Business, Gupta talks about the connection between the four segments driving the economy, households, government, corporates and India’s external trade. Not only the balance sheets of corporates, he argues that policymakers urgently need to focus on the financial situation of Indian households. He says that the country needs to slow down consumption growth to ensure a sustainable long term growth.
Gupta also talked about India’s unemployment problem, sluggish corporate investment, GDP growth and his eight per cent solution in this freewheeling conversation.
You have talked about the gross and net impact of economic policies in your book. As you have argued, it is the latter that matters more than the former when it comes macroeconomy. Do you feel that there is disproportionate attention paid to the former when any policy is announced?
When you look at the headlines after a major policy is announced, they tend to look at the gross impact of these steps primarily, not the net impact. One of the examples that I have cited in my book is the corporate tax cuts. When the finance minister announced the step, there was a lot of cheer from the corporate side as the firms got higher disposable incomes. However, what matters from the macroeconomy side is what was the net impact on overall economy. Due to the tax cuts, the government would see a reduction in revenue, which means that it would either need to accept a higher fiscal deficit or raise its revenue from someplace else.
Immediately after the decision, the stock markets went berserk but the bond markets reacted very cautiously due to the expectation that the fiscal deficit would go up. So, while the move did have a strong gross impact on the corporate sector, the overall net impact on the economy was not so significant in the short term.
Talking about corporate tax cuts, the government announced them with the intention that it could lead to higher private investments. How would you assess the current scenario of private investments?
We need to understand that what matters is profits before taxes because they are derived from economic activity. Coming to the connection between investments and profits, it has been observed that higher investment leads to higher profits. But what we need to note is that profits can go up even in an environment of lower investments. Profits are not only dependent on investments but also on household savings, fiscal deficit and current account deficit.
Looking at the global scenario, except China, corporate investments have come down in the last decade. On the other hand, corporate profits have gone up. This is because the fiscal deficit, current account balance and level of household savings have helped profits.
The current environment is that we have been waiting for investment rate to pick up for many years. In the post-pandemic period, the financial situation of listed companies has improved tremendously. This has led to the narrative that improvement in financial position would lead to higher investments. My analysis says that investment depends on the general economic environment and confidence. Higher profits will lead to higher investment only when existing capacity utilisation hits its peak and if there is an expectation that additional capacity will lead to better profits.
The reluctance of private players to invest creates a problem for government as one of the main criticisms they are facing is the unemployment rate. There is a mention about aligning the interests of private players with national objectives of growth. What do you think the government can do in this environment?
We need to understand that the government cannot do everything. On one hand we say that government has no business to be in business. However, we also expect that if there is a problem in any part of the economy then the government should intervene and correct it. That is a very lopsided expectation.
It is not the duty of the corporate sector to generate employment. It is just the byproduct of the process of maximising profits. The primary objective of any corporate firm is not social service but to generate profits for promoters and shareholders. I have mentioned in the book the example of South Korea during the 1950-60s when its ruler aligned the corporate sector with national objectives forcefully. That is just not possible now. Neither it is possible nor is it suggested in the current world.
What the best minds of the government need to do is to strategise how we can make opportunities more profitable for companies so that they can participate in fulfiling these objectives. Serious deliberations need to be held about this.
As per available data, the unemployment scenario for youth has worsened considerably over the years. What do you think are the primary reasons behind this trend?
It is a serious challenge that needs to be tackled immediately. This concern is not something new. The only good employment generation period, not only for India but for world, was from 2004 to 2008. This was the high growth phase. On this, there is a correlation between the global economy and Indian economy.
There are several structural problems. We know that the female labour participation rate is low, but we don’t know whether it is due to economic factors or cultural factors. Along with this, India’s growth story transitioned directly from agriculture to services sector. During the high growth period of several east Asian countries, it was manufacturing that picked up which has not been the case for India. The manufacturing sector is a big employment generator. If we move directly to services, then it has to absorb the workforce leaving agriculture. I don’t think there is any quick fix to this issue.
Coming to the manufacturing sector, you have mentioned in your book that FDI in the sector has been going down across the world. Given this trend, do you think the time for growth model that developed countries previously relied upon has gone and there are new trends emerging globally?
There is a reason why investments have been going down decade after decade. The reason is that the growth model globally has shifted from manufacturing to the services sector. The latter is not as investment intensive as the manufacturing sector, which is why we see the trend of declining investments.
India is not in the same stage of development as China or United States. Both of them have gone through a phase of development where they moved from agriculture to manufacturing to services. In my opinion, this is the ideal way. However, India missed the bus due to factors beyond our control. We got independence in 1947 and started our liberalisation in 1991, which could have been done earlier.
Now the world is moving to a growth model which focuses on productivity than employment. Employment growth has reached a saturation point in most of the developed countries. In these countries, most of the growth is coming from productivity gain not employment gain. If that is the case, Indian companies cannot adopt a different model. So, these firms will have to go for processes which are more capital intensive rather than labour intensive. This tradeoff creates a big problem for a country like ours.
One of the key focus areas of your book is the deteriorating household savings situation in the country. You have argued that we need to accept slower growth in order to rebuild the finances of this segment. Why do you think it is necessary for the policymakers to pay heed to this?
Falling household savings is one of the key concerns. I have suggested in my book the possible solutions, but I would say that these are not very positive solutions. What I have suggested is that we accept slower economic growth to resolve this problem.
Consumption and savings are two sides of the same coin. If income growth is not picking up, and it has been stable at 5 to 6 per cent, then it’s not possible for consumption to grow at 7 per cent without eating into savings, which is what has happened. For the past many years, consumption growth has outpaced income growth which is why savings have gone down.
If we continue to follow this trend, the consequence of this would be that either investments will continue to fall, or we will soon run into an external deficit crisis. My recommendation is that we need to slow down consumption growth. If it slows down, we will also see a slowdown in our GDP growth which would recreate the 1999-2003 situation. While GDP slowed down and inflation eased, savings picked up in this period which helped India run a current account surplus for three years. When Indian and global economy picked up from 2004, the deficit worsened. However, as we had created space in the previous years, we were able to grow at a good pace without creating imbalances in the current account.
We need to see the repeat of this scenario in my opinion to create a space for faster sustainable growth in years to come.
The 8 per cent solution that you suggest calls for improving the financial situation of households and consolidating the fiscal deficit of the government. Won’t this lead to an environment where private players lose the incentive to invest in the economy and the situation can worsen even further?
There are three scenarios that can play out. First, savings can pick up and investments rate go down which means that the country will start running a current account surplus again. We need to understand that savings are nothing but supply of funds in the country and investments are demand of these funds. If there is a greater supply than demand, it will lead to a decline in interest rates. This would make it comfortable for companies to expand at a later stage.
Alternatively, the demand may not pick up despite slower growth, however, as we have established, the cost of funds would go down, which could incentivise the companies to invest in building capacity to export products. The cost of labour would also go down in this scenario, which could make companies more competitive. Exports can become an engine of growth through this. This is what happened in most of the east Asian countries.
The only thing we need to ensure is that the corporate sector does not lose its dynamism and feel dejected. This can happen if the players know that what is happening is planned to help rebuild the economy.
The third scenario is that we continue to push consumption growth and not pay attention to falling household savings. In this scenario, you will see higher GDP growth in the near term. However, a time will come when either inflation or our current account deficit becomes uncontrollable.