Demand collapse: What does the story of the one handed economist tell us about the Indian economy

harry trumanVivek Kaul
The story goes that Harry S Truman, the president of the United States between April 1945 and January 1953 once asked for “a one handed economist”. “All my economists say, ‘on the one hand…on the other,” he bitterly complained.
The question is why do economists do that? Why do they have a tendency to argue both ways? Why can’t they be more clear about things? One reason for this is the fact that different economic data often point in different directions, and this produces many “on the other hand” kind of economists.
Very rarely, does different economic data point in the same direction. And that is happening in the Indian case right now. Different economic data are all clearly showing that there has been a collapse in consumer demand.
Let’s start with the trade deficit for February 2014, which was declared on March 11, 2014. Trade deficit is the difference between imports and exports. The trade deficit fell by 42.1% to $8.1 billion. This fall was primarily on account of imports coming down by at 17.1% to $33.82 billion.
Imports fell because of a 24.5% fall in non oil imports to $20.1 billion. Non oil imports were at $26.7 billion in February 2013. This means a fall of $6.6 billion. One reason for the fall in non oil imports was the fall in gold imports. Gold imports in February 2013 were at $5.24 billion. This year they fell to $1.63 billion, a difference of $3.61 billion.
As mentioned earlier total non oil imports fell by $6.6 billion during February 2014. What this clearly tells us is that fall in non oil imports is not just because of a fall in gold imports. A major part of the fall is clearly because of a lack of consumer demand for imported goods.
Now let’s look at the index of industrial production(IIP) for January 2014. The IIP is a measure of the industrial activity in the country. This data was declared on March 12, 2014. The overall index grew by just 0.1% during January 2014. While this is an improvement over the last few months, it is nothing worth getting excited about.
Manufacturing which forms a little over 75% of the index fell by 0.7% during January 2014, in comparison to January 2013. This primarily is on account of the slowdown in consumer demand. When consumers are going slow on purchasing goods, it makes no sense for businesses to manufacture them. When we look at the IIP from the use based point of view it tells us that consumer durables (
fridges, ACs, televisions,computers, cars etc) are down by 8.3% in comparison to January 2013. The overall consumer goods sector is down by 0.6%. The lack of demand also means that the investment climate for businesses is not really great. This is reflected in the lack of capital goods growth, which was down by 4.2% during January 2014.
This slowdown in consumer demand was also reflected in the gross domestic product(GDP) numbers declared around two weeks back. If we look at the GDP from the expenditure point of view, the personal final consumption expenditure(PFCE) for the period October to December 2013, formed 61.5% of the total expenditure during the period. In September to December 2012, the PFCE had formed around 62.7% of the total expenditure.
What this clearly tells us is that PFCE is not rising as fast as other expenditure. In fact, during the period, the PFCE rose by just 2.6% to Rs 9,81,463 crore in comparison to September to December 2012.
Interestingly, during the period September to December 2012, the PFCE had grown by 5.1%. What this clearly tells us is that people are going slow on personal expenditure. The reason for that is high inflation which has led to more and more money being spent on meeting daily expenditure. Retail inflation in general and food inflation in particular has been greater than 10% over the last few years, and has only recently started to come down. Hence, people are postponing all other expenditure and that has had an impact on economic growth. One man’s expenditure is another man’s income, after all.
So where does that leave inflation? The consumer price inflation for February 2014 came in at 8.1%. It was at 8.79% in January 2014.
A major reason for the fall has been a fall in food prices. Food prices in February 2014 rose by 8.57% in comparison to last year. This, after constantly showing a double digit growth for a long time. Interestingly, food prices fell between January and February 2014. The question is will food prices continue to fall after falling for three straight months? The answer is no. Unseasonal rains and hailstorms in parts of the country have damaged crops, and this is likely to push up prices again.
Food prices form close to 50% of the consumer price index, which is one of the measures of inflation. Also, food forms nearly half of the expenditure of the average Indian household. Hence, for any pick up in consumer demand to happen, food prices need to continue to stay reasonable.
Further, non fuel-non food inflation, or what economists refer to as core inflation, fell by around 20 basis points (one basis point is one hundredth of a percentage) to 7.9%. This has been proving to be a tough nut to crack. Non fuel-non food inflation takes into account housing, medical care, education, transportation, recreation etc. If consumer demand has to be revived it is important that core inflation continues to fall, over a period of time. Along with this food prices need to continue to fall as well.
If that happens, then some consumer demand is likely to come back.

The article originally appeared on on Marcy 13, 2014
 (Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why Chidu's new plan to revive consumer demand won't work

The finance minister, P Chidambaram is at it again. He wants public sector banks to cut their interest rates so that people borrow and spend more, and consumer demand improves.
The trouble is that the credit deposit ratio of banks is at extremely high levels. Latest data released by the Reserve Bank of India(RBI) shows that as on September 6, 2013, for every Rs 100 that banks borrowed as deposits, they had lent out Rs 78.52.
Banks need to maintain a cash reserve ratio of Rs 4 for every Rs 100 that they borrow as a deposit. This money is deposited with the RBI. They need to maintain a statutory liquidity ratio of 23% i.e. invest Rs 23 for every Rs 100 they borrow as a deposit in government bonds.
This means that Rs 27 out of Rs 100 that is borrowed as a deposit goes out of the equation straight away. Only the remaining Rs 73 can be lent out. But banks are lending Rs 78.52 for every Rs 100 that they raise as a deposit. This means that they are borrowing from other sources in the market to lend money.
This is happening primarily because banks have been unable to raise enough money as deposits. The deposit growth in one year(between September 7, 2012 and September 6, 2013) was at 13.5%. In comparison the loan growth has been at 18.2%.
Given that loan growth has been happening at a much faster rate than deposit growth, banks cannot cut interest rates. To cut interest rates on loans, banks will have to first cut interest rates on deposits. And if they do that they will find it even more difficult to raise deposits.
But Chidambaram seems to have found a way to get around this problem. A finance ministry press release pointed out yesterday that “It may be recalled that in the Budget for 2013-14, a sum of Rs. 14,000 crore was provided for capital infusion. This amount will be enhanced sufficiently.
The additional amount of capital will be provided to banks to enable them to lend to borrowers in selected sectors such as two wheelers, consumer durables etc, at lower rates in order to stimulate demand.”
There are multiple problems with this plan. Where will the government get the money for the extra capital it is planning to offer to banks? It will borrow money by selling bonds, which will be bought by banks and other financial institutions. And where will the banks get this extra money to lend to the government? By trying to raise more deposits. And how will they do that? By offering higher interest rates.
The second and the bigger problem with the argument is that the size of loans for two wheelers, consumer durables etc is too small, for a fall in interest rates to make any difference. Lets assume an individual takes a two year two wheeler loan of Rs 50,000 from SBI at 18.05% per annum. The EMI for this comes to Rs 2497.4. If the interest rate falls to 17.05% per annum, the EMI will fall by around Rs 24 to Rs 2473.3. If the interest rate falls to 16.05% per annum, the EMI will fall by around Rs 48 to Rs 2449.35.
Of course no one is going to go ahead and buy a two wheeler because his EMIs have come down by Rs 24-48. When it comes to these kind of purchases interest rates don’t really matter. What matters is how people feel about their economic future. Questions like whether they will get a raise this year or even whether they will keep their job in the time to come are more important.
Given the bleak economic scenario that prevails, Chidambaram’s plan won’t work.

The article originally appeared in the Daily News and Analysis dated October 5, 2013 with a different headline
(Vivek Kaul is the author of soon to be published Easy Money. He tweets @kaul_vivek)