Is Indian middle class responsible for keeping the economy ticking?

There is a certain kind of citizen in India today who is a Narendra Modi supporter purely for the economic future he has shown her. Fed up of rampant corruption and an inefficient system, she is aspirational but willing to sacrifice when the prime minister gives the call. She stood in line for hours for a little ration of cash. She gave up cooking gas subsidy when he said he could use it to help the poor. And ignoring social unrest, demonetisation pangs and dire warnings from opposition critics, she voted with gusto for the Bharatiya Janata Party (BJP) in state elections, a clear thumbs-up to Modi the reformer. “Today, middle class has to bear the greatest burden of taxes, of rules and regulation, and observe social norms. The quantum of economic burden for the middle class is the most. This should reduce; the middle classes want hurdles to be removed so that they can be achievers. Once the poor begin to carry their own burden, the burdens on the middle class will reduce,” Modi acknowledged after BJP captured power in four states, including Uttar Pradesh, in March. All modern economies have progressed by creating jobs and expanding the middle class whose consumption then becomes the main growth driver. The middle class in India is currently responsible for the seeming calm in the economy which may otherwise be hiding storms of worsening balance sheets—private and public—beneath. Yet it is now increasingly bearing a disproportionately large burden and is unlikely to be able to sustain it for long. While the poor took solace in the illusion that the rich were penalised by demonetisation, the middle class stoically bore the brunt in the faith that it would ultimately contribute to a cleaner financial system. There were no protests when on August 1, the government announced that it will bridge the Rs 87 subsidy gap in LPG price faster than earlier which means ordinary customers will pay the full price from April. That is nearly double of what they used to pay before subsidy began to be phased out two years ago. Kerosene subsidy also will be completely phased out in a few months. Soon all fuel will be sold at market rates. While industrialists hesitated to invest in new projects and businesses continued to cut costs, mainly jobs, the middle-class Indian continued to spend on clothes, vehicles and durables, keeping the economy ticking. She paid her taxes, 40% more in the June quarter over a year ago. Her savings have flowed to the government, helping it sustain its own spending which seems to be the only engine that is firing. She did not complain when small savings interest rates were progressively brought down, the last 10 basis points cut coming on July 1. “At the moment, the middle class is the sole pillar holding up the economy. It is their savings that are financing the government,’’ says NR Bhanumurthy, professor at the National Institute of Public Finance and Policy (NIPFP). After resisting pressure from the government to cut rates over the past few months, the central bank eased rates by a token 25 basis points. It, however, listed several factors that could build upward pressure on prices, indicating that it remains trigger happy for the slightest inflationary provocation. The 25-basis point rate cut appears to help nobody except the government. Its fiscal deficit has crossed 80% of budget estimates in the first quarter itself and primary deficit has zoomed more than 1,314% at the end of June. It has already borrowed 64% of its year’s targeted net borrowing of Rs 3.5 lakh crore despite buoyant advance tax collections. The government’s borrowing cost will come down even more after the rate cut— the 10-year bond yield ended at less than 6.5% after the cut–and the middle-class Indians, majority of whom keep their money in banks, would earn less. The middle-class engine could lose steam if private investments do not take off and new jobs are not created. And that is unlikely to happen anytime soon. Business sentiment continues to be subdued and private investors are not putting money on the ground. The trend is likely to continue. “High levels of stress in twin balance sheets – banks and corporations – are likely to deter new investment. With the real estate sector coming under the regulatory umbrella, new project launches may involve extended gestations and, along with the anticipated consolidation in the sector, may restrain growth, with spillovers to construction and ancillary activities,’’ the RBI said in its third bimonthly monetary policy statement August 2. The Nikkei India Manufacturing Purchasing Managers’ Index, or PMI, dropped to a near eight-and-a-half year low of 47.9 in July from 50.9 in June. Services PMI for the month slipped to a four-year low of 45.9 from 53.1 in the previous month. The numbers below 50 indicate a contraction in activity, mainly because of the country’s shift to a uniform goods and services tax and consequent temporary disruption. “Private sector activity dipped for the first time since the demonetization shock” and “most of the contraction was attributed to the implementation of the goods and services tax and the confusion it caused,” Pollyanna De Lima, principal economist at IHS Markit, a London-based financial services company, said in the report. Rs Rs Faced with fewer workloads, service providers and manufacturers lowered payroll numbers in July.’’ A few days ago private data compiler CMIE said the country’s formal sector lost 67 lakh jobs between January and April. The trend appears to have continued into the next quarter. CMIE estimated total job losses—formal and informal together—at 1.5 million. KE Raghunathan, national president of All India Manufacturers Association, which largely represents small and medium enterprises, told ET that a survey of their members showed 35% job losses in the informal sector. Beaming headlines of soaring equity markets have helped paint a rosy picture but they hide an inherent fragility in the Indian economy. Four years ago, global broking firm Morgan Stanley put India in a dubious group of countries that depended on foreign investors for their growth. They called the group which included Indonesia, Turkey, South Africa and Brazil, the ‘Fragile Five.’ A year later, India was out of the club and was repositioned as a potential high-performer; stable and poised to take off. Last year, IMF chief Christine Lagarde called it the lone “bright spot’’ in an otherwise gloomy economy. The talk-up rubbed off on Indian stocks which have rallied for several months putting local equity markets ahead of global peers. On July 25, the NSE’s Nifty index crossed 10,000, an important psychological milestone. The rally was almost entirely fuelled by liquidity, both domestic as well as dollars pumped in by foreign portfolio investors (FPIs). The government has also raised the cap on FPI investment in debt instruments, making sure that even if equities become expensive, the dollars will stay in local debt instead of flowing out of the country. In 2017-18 so far, FPIs have invested Rs 1,07,269 crore, Rs 90,768 crore of it in debt. This cushion rests entirely on returns from other global assets remaining lower than Indian assets. NIPFP’s Bhanumurthy believes foreign investors would put money in India even though domestic businesses are hesitant to invest in projects. “The long-term India story is intact. Confidence channel would help revive the Indian economy, not the interest rate channel.’’ Meanwhile, one storm lurking beneath the surface is perhaps gaining momentum. It is the worsening finances of states. In its study of state budgets the RBI said the fiscal deficit of states as a proportion of GDP crossed 3% in 2015-16 for the first time in a decade. Information from 25 major states suggested slippages in deficit indicators in 2016-17. Although the RBI has said that the debt levels are sustainable in the long run, it had not considered big surprises such as farm loan waivers. Close on the heels of the Centre implementing the 7th pay commission recommendations, states are also contemplating their own pay revisions which will add pressure on public finances. As other economies, especially the US, start improving, the risk of capital flight from India increases. The government has to goad private capital to start investing in projects that create jobs and livelihoods. Bank balance sheets have to be cleaned up faster and they need to be capitalised enough to start funding entrepreneurs again. Otherwise the middle-class Indian will collapse under the weight of the economy.
Source: ET

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