Ecowrap ‘Be the Bank of Choice for a Transforming India’

Issue No. 32, FY20

ROOT CAUSE OF THE CURRENT DEMAND SLOWDOWN Date: 14 August 2019

The global economy is currently in uncharted territory. The assumptions which we hold for reasonably predicting the future do not seem to be
holding up and the global economy is witnessing outlier events on a daily basis, the occurrence probability of which is practically non existent
given our assumptions. For example, Argentina's Stock Market declined by 38% in a single day, the largest 1-day decline in its history. Independ-
ent observers suggest that this was a 17-sigma event which means that it should not have happened even once in the history of the universe!
Meanwhile, the reasons for the current domestic slowdown, apart from the global uncertainties look like a combination of both structural and
cyclical factors. We find that for the Indian economy there are clearly a host of structural factors that are holding back current consumption. A
substantial decline in wage growth (both rural and urban wages) in recent times resulting in lower household savings (a result of conscious
policy decisions to correct macro imbalances) has possibly slowed down the growth in real per capita income that is holding back demand.
Interestingly, the slowdown in auto demand is not restricted just to India, but the impact is felt across geographies with China also facing the
brunt of auto-slowdown. Even in US, after a long period of auto-slowdown, the July numbers gave some respite but that also may be an impact of
the base effect. In Germany too, the auto-sector witnessed a production decline of 12% in the first half of the year. Daimler reported a loss of
Euro 1.6 bn and Audi registered a decline of 4.5% in sales. The criticality of Automobile sector can be gauged by a humongous 30 million
employment on a per annum basis which it generates. Out of this more than 50% could be of contractual nature, hence the seriousness of the
current auto slowdown.
Cyclical factors like the recent NBFC crisis, tax and sector specific issues are also holding back current consumption. It will be thus pruden t to
address the current slowdown with a combination of countercyclical measures / say, sector specific intervention, addressing tax and MSME is-
sues and structural measures/ expediting stressed asset resolution, reforming rural markets, addressing export competitiveness etc.
Finally, though slowdown in demand is a fact, but there is a misplaced consensus that banks are not extending enough credit to help us
navigate through the current slowdown. This is a false narrative as economic theory suggests a bi-directional causality between economic growth
and credit off-take. Thus, a growth slowdown will percolate into a credit slowdown and not vice-versa. For the record, in the last
3-year period ended FY19, incremental bank credit to economy was at Rs 20.3 lakh crore, of which Agriculture received Rs 2.3 lakh crore,
Services Rs 8.8 lakh crore, Retail /Personal at Rs 8.3 lakh crore (Housing at Rs 4.1 lakh crore) and Industry at Rs 1.5 lakh crore! In the
comparable period, GDP expanded by Rs 36.5 lakh crore! The slowdown in credit to industry is the result of several structural reforms and
disruptions, apart from deleveraging and asset quality issues beginning FY16.

DEMAND SLOWDOWN
 There are currently three issues that beg an answer from the
policy makers. First, what are the reasons for the current demand
slowdown; second, whether the current slowdown is structural or Sector-wise Bank Credit Share (%)
cyclical and third, whether the banks have stopped lending and
hence causing demand disruptions. Let us address them one by
one, but in the reverse order!
 Though Sslowdown in demand is a fact, but there is a misplaced
consensus that banks are not extending enough credit to help us
navigate through the current slowdown. This is a false narrative
as economic theory suggests a bi-directional causality between
economic growth and credit off-take. Thus, a growth slowdown
will percolate into a credit slowdown and not vice-versa.
BANK CREDIT IS THE EFFECT AND NOT THE CAUSE OF SLOWDOWN
 In the last 3-year period ended, FY19, incremental bank credit to
economy was at Rs 20.3 lakh crore, of which Agriculture received
Rs 2.3 lakh crore, Services Rs 8.8 lakh crore, Retail /Personal at Rs
8.3 lakh crore (Housing at Rs 4.1 lakh crore) and Industry at Rs 1.5
lakh crore! In the comparable period, GDP expanded by Rs 36.5
lakh crores. In Q1FY20, retail loans have continued to expand at
Rs 46,000 crore (bank credit though have a shown a de-growth of
Rs 1.3 lakh crore, led by Industry) even though some segments of Source: SBI Research
retail loans like vehicles have indeed registered negative growth
revealing clear lack of demand and other cyclical issues afflicting
the auto sector.

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 Incremental bank credit doubled its pace in FY19 compared
to FY17. The slowdown in bank credit, if any is primarily the
result of credit to Industry, that first declined in FY17, barely
managed a positive incremental number in FY18, but has
somehow picked up pace in FY19 (10 times larger vis-à-vis
FY18). This is the result of several structural reforms and
disruptions, apart from deleveraging and asset quality issues
beginning FY16. It is thus foolhardy to blame bank credit for
current demand disruption. It is rather the lack of demand
for bank credit, which is causing the slowdown.
 This brings us to the reasons behind the current demand
slowdown and how to label it: structural or cyclical or both.
This labelling is important, as a structural would imply
macro reforms and ignoring business cycles, while a cyclical
would mean unleashing counter cyclical policies. We believe
the current slowdown is a combination of both structural
and cyclical factors, as we will shortly explain.
INCOME AND WAGE GROWTH: STRUCTURAL FACTORS
IMPACTING CURRENT SLOWDOWN
 First, what are the structural factors that might have
resulted in the current demand deceleration? We believe
the most crucial factor that is reinforcing the demand
slowdown is slow growth in both corporate wage (a proxy
for urban wages) and rural wage. Corporate wage (based on
company financials of 4,000 to 5,000 companies), which
used to expand in high double digits (peak at 20.5%) post
the crisis is now down to single digits as corporates are
more conscious of cost in the midst of a massive deleverag-
ing cycle. In a similar vein, rural wages also declined from
double digits (peak at 27.7%) growth till FY15 to less than
5% in last three fiscals. Clearly, this high growth phase was
unsustainable (a deadly cocktail of wage-inflation nexus).
THE DECLINE IN SAVINGS IS A BYPRODUCT OF STAGNATING PER
CAPITA INCOME, HIGH REAL INTEREST RATE AND DEPENDENCY
RATIO
 According to the life cycle model, real interest rate is an
important determinant of private saving. There are two
offsetting effects of real interest rate (RIR). As RIR increases,
the opportunity cost of consumption relative to the future
cost rises and it encourages people to save more. This is the
substitution effect. However, the higher real interest rate
tends to increase the lifetime income of the lenders and
thereby encourage consumption and discourage savings. This
is the income effect. The net effect on savings will be
negative if income effect outweighs substitution effect.
 Our empirical analysis suggests that long-run effect of real
interest rate on private saving rate is negative and statistically
significant at the 1% level. In our case, the income effect
appears to be dominant. In India the real interest rate (RIR)
has increased from 1.72% in Mar’18 to 3.39% in Mar’19
though currently it stands at 2.2%. A country-wise analysis of
real interest rates indicates that India has one of the highest
level of real interest rate.
Income and Wage Growth (%)
Wage & Income Growth (%, YoY)
30.0 8.0
7.0
25.0
6.0
20.0
5.0
15.0 4.0
3.0
10.0
2.0
5.0
1.0

However, the bottom line is the subsequent decline in wage 0.0 0.0
FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19
growth and structural changes resulted in stagnating per
capita income growth (in real terms) and hence to keep the Rural Wage Corporate Wage Real Per capita NNI_RHS

consumption expenditure at the same level, household

savings also declined. Source: SBI Research

CYCLICAL FACTORS IMPACTING CURRENT SLOWDOWN Country-wise Real Interest Rate (%)
 But it is naïve to say there are no cyclical factors. For Central Bank CPI (% Real Central Bank
Country
example, to solve the NBFC crisis and the recent tax Policy Rate (%) YoY) Policy Rate (%)
imbroglio we need more confidence building countercyclical Brazil 6.00 3.40 2.60
measures. In a similar vein, private investment is currently a Indonesia 5.75 3.30 2.45
significant laggard in total investment. The share of private India 5.40 3.15 2.25
sector has declined from 50% during 2007-14 period to 30% Philippines 4.50 2.40 2.10
during 2015-19 period in new projects investments (in value China 4.35 2.70 1.65
-terms). A possible increase in current capacity utilization (at Malaysia 3.00 1.50 1.50
76.1%) can happen only if we simultaneously address the US 2.13 1.80 0.33
sector-specific issues in order to boost demand of bank Canada 1.75 2.00 -0.25
credit. One such is the MSME sector, where delayed Australia 1.00 1.60 -0.60
payments of receivables for MSMEs needs to be monitored. New Zealand 1.00 1.70 -0.70
Similarly, to improve transmission in MCLR, both asset and Japan -0.10 0.70 -0.80
liability side of Bank balance sheet need to move UK 0.75 2.00 -1.25

simultaneously and that is already happening. Eurozone -0.40 1.10 -1.50

Source: SBI Research

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SLOWDOWN IN AUTOMOBILE SEGMENT: CAUSES & IMPACT Auto sale vis a vis nominal per capita Income (%)
 In our previous report on auto sector, we had raised our 35.0 20.0

concern about the falling automobile sales and the steep 30.0 18.0

slowdown in auto sector since the past 4 quarters. The 25.0

16.0

14.0
analysis highlighted some of the factors such as declining 20.0
12.0
lending by NBFCs, declining rural demand, increase in the 15.0
10.0
cost of insurance etc. and change in policy on axle norms 10.0
8.0
leading to increase in existing carrying capacity of the 5.0
6.0
commercial vehicles. 0.0
4.0

2018-19
 Besides these, the study also highlighted impacting factors

2011-12
2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2012-13

2013-14

2014-15

2015-16

2016-17

2017-18
-5.0 2.0

like increase in used car markets, launch of Electric Vehi- -10.0 0.0

cles and EV policy and increased usage of care rentals etc. Auto Sales Growth Per Capita NNI Linear (Auto Sales Growth) Linear (Per Capita NNI)

 In present day interconnected trade, production of single Source: SIAM, SBI Research
good spans across many economies because of the global
value chain of that product. A slowdown in Industry like  The per capita NNI (current prices) growth which was in
automobile leaves a cascading impact across the value double digits continuously up to 2013-14 declined to single
chain. digits from 2014-15 and has registered a growth of 9.8% in
 However, automobile slowdown is currently a global 2014-18. The Automobile sales have also been tracking the
phenomenon. For instance, China car sales declined for same. The trend line suggests a declining trend over the
the 13th month in a row in July to -3.9% YoY. Retail past years, which initially ran parallel, but started
numbers of car sales were worse at -5.3% YoY. So falling converging now with per capital NNI witnessing a steeper
auto sales seems to be a global phenomenon with China, decline as compared to auto sales.
India, EMs. IMPACT ON EMPLOYMENT
 Studies done in the sector show that Auto sales in Asia-  The prolonged slowdown in auto sales has impact on
Pacific, estimated at around 43-44 million vehicles in the employment in this sector. Automobile sector is one of the
previous year, are expected to fall 2-3.5% this year after largest employment generating sector in the economy and
declining roughly 1% in 2018. Even in Germany, the our conservative estimate suggests that this sector is able
automotive production declined by 12% in the first half of to generate around 25 lakh incremental employment per
this year owing to falling sales in the US and China. year. This slowdown will have huge impact in the form of
OTHER FACTORS CAUSING AUTO-SLOWDOWN low demand of drivers, helpers, etc.
 Government Dictum to move straight into Euro VI (Fuel  Further, Automobile component manufacturing sector has
Emission) norm from 2020. This has resulted in consumer already witnessed 10-15% loss in employment and since
postponing their purchase of current vehicles. The In- around 70% of employment is contractual basis in this
creasing usage of share taxis like UBER and OLA. Challenge sector a 15-20% production can cut lead to job loss of the
being posed by the Indian railways to Commercial vehicles same magnitude.
by developing dedicated freight corridors across the west-
ern and the eastern belt of the country. Incremental Payroll in Automobile Industry during FY19
 The agri-stress and the liquidity crisis in NBFC segment has Category
Sales Replacement Rate Employment Capacity
started reflecting on tractor sales as on one side income is in Lakh % % in Lakh
Passenger Vehicles 33.8 25% 25% 6.3
reduced and on the other the lending is also impacted.
Commercial Vehicles 10.1 40% 200% 12.1
INCOME GROWTH AND AUTOMOBILE SALES
Three Wheelers 7.0 25% 150% 7.9
 While automobile sales do have a correlation with the Total 50.9 - - 26.3
aforesaid factors, but its direct correlation with income Source: SBI Research
cannot be ignored and the figures also indicate the same.

Disclaimer: The Ecowrap is not a priced publication of the Bank. The Contact Details:
opinion expressed is of Research Team and not necessarily reflect those of Dr. Soumya Kanti Ghosh
the Bank or its subsidiaries. The contents can be reproduced with proper Group Chief Economic Adviser
acknowledgement. The write-up on Economic & Financial Developments is State Bank of India, Corporate Centre
based on information & data procured from various sources and no re- M C Road, Nariman Point
sponsibility is accepted for the accuracy of facts and figures. The Bank or Mumbai - 400021
the Research Team assumes no liability if any person or entity relies on Email: soumya.ghosh@sbi.co.in
views, opinion or facts & figures finding in Ecowrap. gcea.erd@sbi.co.in
Phone:022-22742440
:@kantisoumya