Message to PM & FM from IIP shocker: forget politics, get to good economics

The shocker of a number in the October Index of Industrial Production (IIP), at minus 4.2 percent, is going to negate completely the sharp drop in retail inflation in November, which saw the Consumer Price Index at 4.38 percent (down from 5.52 percent).

This IIP number is actually worse that it already looks because last October the index had fallen 1.2 percent, which means the base effect for this year should have been a positive. But none of that happened. What’s going wrong?

In two words: consumer confidence. Even as the markets and businessmen have been chirpy (so far), the average Indian consumer is simply not convinced that she should be splurging on anything.

The sharpest drop among IIP components was seen by the consumer industries, both durables and non-durables. Non-durables (which means things like soaps, toothpaste, food items and toiletries) fell a precipitous 4.3 percent in October. Normally, people don’t put off everyday purchases unless something is seriously wrong.

But the bottom has really fallen out of durables which crashed 35.2 percent . People are simply not buying more fridges, plasma TVs or computers or even mobile phones. And remember, this was October - the traditional festive season when people loosen the purse-strings. People are holding on to cash and not spending.

This aspect is borne out by bank credit growth, which has been a weak 11 percent. Worse, credit to the non-food sector (which means largely industry) crashed by more than 17 percent year-on-year in November 2014.

So this is the dismal picture: consumers are not buying, industry is not investing, banks are not lending.

It is difficult to say why this might be happening, but a few hypotheses can be trotted out.

First, three years of big cuts in plan and capital spending by the central government (from 2011 to 2014 and still continuing) are taking a toll on industrial demand. When you cut productive expenses, you effectively destroy demand for businesses which supply to government - which is a huge part of demand.

Second, the NDA government’s entry into the picture has not changed matters. In fact, one suspects that the promise of better things to come (achche din) may now be working against growth as businesses wait to see what kind of goodies are in store for them. The coal mine cancellations and the prospect of telcos having to bid again for spectrum when their licences expire means investors are holding on to cash. The investment cycle has not turned.

Third, banks are not in a rush to lend despite lowering deposit rates. This is because they are stuck with huge bad loans, and the government has not capitalised them enough to start lending again. The sharp fall in oil prices also means that their overall lending to the oil marketing companies - always big borrowers - may be sharply down. Falling oil prices may be good for the oil companies, but bad for banks who now can’t lend to safe public sector refiners.

The message that Narendra Modi and Arun Jaitley should take out is clear and three-fold:

#1: Jaitley must ease up on the fiscal deficit and start spending on projects. This will revive demand in the first quarter of next year. Even more important, tax cuts are more important for individuals in the next budget. Jaitley has to abandon Chidambaram’s focus on the fiscal deficit in the short-run.

#2: Modi has to push ahead with big reforms. He must, must, must privatise - some banks and some public sector companies. There is no reason why he should keep companies like Air India in the ICU, financed by taxpayers.

#3: Reforms are no longer an optional extra just because we have a functioning PMO. Modi has to get some big reforms going. An insurance bill here and a coal mines bill there are not enough. He has to get big changes done in the Land Acquisition Act at the very least. If he does this, he can expect some revival in demand at least in the first or second quarters of fiscal 2015-16.

Modi and Jaitley have to act. And act fast. If they do not get their act together by February-March and the budget session, they will have only themselves to blame. They too will fall on their own swords - like Manmohan Singh and Chidambaram did.

In fact, they should move right now with more reforms, even if elections are underway in J&K and Jharkhand. An election lost may not matter much in the BJP’s long march to dominance, but an economic opportunity lost is simply unforgiveable.