Reviving sentiment could be key to battling economic slowdown

High-frequency economic indicators suggest that the current economic slowdown is likely to worsen. The core-sector industry index grew just 0.2% in June. India’s biggest carmaker Maruti Suzuki reported a 36% annual decline in car sales for the month of July. The stock market has gone into a tailspin after the budget was unveiled on July 5.

How bad are things right now? A long-term comparison of key economic indicators shows that things have been worse.

GDP first. It has been going down for four consecutive quarters beginning June 2018. If the June 2019 GDP growth numbers are lower than the 5.8% value for March 2019, then we would have had a decline in GDP growth for five consecutive quarters. Since June 1997, there have been only two instances of GDP growth declining for five consecutive quarters, between March 2008 and March 2009, and March 2011 and June 2012. To be sure, the growth rate in the current phase is still higher than what it was during those periods. However, it is also a fact that the veracity of current GDP numbers is the subject of controversy.

See Chart 1: Quarterly GDP growth rate

There is evidence to suggest that aggregate demand – both foreign and domestic – is stalling. Export growth and the core sector industry index support such as a prognosis, where a short-lived recovery seems to be reversing itself. Still, the performance of both the core sector and exports have been worse on several occasions in the past.

See Chart 2: Export growth and core-sector index

One reason why people feel as bad as they do about the economy may be the sentiment.

The deceleration in the real economy is coming at a time when economic sentiment is already stretched too thin. The Reserve Bank of India’s consumer confidence index clearly shows this. The index seeks responses to the current general economic situation and what people expect it to be a year from now. Future expectation is a good metric of people’s belief in the ability of a government to handle the economic situation, especially during a crisis.

See Chart 3: General economic situation current and future perception

These two measures were moving in tandem (a declining trend) under the second United Progressive Alliance (UPA) government that bowed out in 2014. There was a sharp recovery in future expectations after the 2014 results gave a clear majority to the Bharatiya Janata Party (BJP). Both the present and future indices were improving until November 2016. This is the month when demonetisation happened. The current situation index turned negative after that, even as future expectations remained stubbornly positive. There was a brief spike in the current perception index in March this year (just before the elections), but it collapsed again in May. This has been accompanied by a big fall in future expectations as well.

The consumer confidence index trends convey an important point. The present government has had a very long rope in terms of being expected to deliver on the economy. The lack of any coordinated policy response to deal with the current, and perhaps worsening, the economic slowdown is affecting future expectations adversely.

Expectations play a very important role in present economic decisions. If people do not expect things to improve, they will postpone or worse, cancel investment and spending decisions. This will feed into the slowdown and trigger a vicious cycle. There is an urgent need to prevent economic sentiment from plummeting further, even if it entails things such as the government appearing pro-business, rationalisation of revenue targets, or even letting go of the fiscal consolidation roadmap.