For the nth time, we’ve a demand problem, fixing supply side won’t help

A total of 15.12 million two-wheelers (motorcycles, scooters and mopeds) were sold in India in 2020-21, the last financial year. This is lower than the 15.98 million sold in 2014-15 and slightly higher than the 14.81 million sold in 2013-14.

Of course, a simple explanation for this lies in the fact that due to the pandemic running right through FY21, people did not buy as many two-wheelers as they would normally have. And that’s right to some extent.

Nevertheless, the total number of two-wheelers sold in 2019-20 had stood at 17.42 million, lower than the 17.59 million sold in 2016-17. Clearly, two-wheeler sales have stagnated over the years.

A two-wheeler is probably the second or third most expensive thing an individual or a family buys in their lifetime, after a house and/or a car. Also, many more Indians own a two-wheeler than a car. Hence, it is an excellent indicator of Indians’ purchasing power at any given point of time.

Having said that, a similar trend can be seen even in domestic passenger car sales. They were at 1.54 million in 2020-21. In comparison, car sales were as high as 2.03 million in 2011-12, nearly a decade ago. In 2019-20, it had fallen to 1.7 million, in comparison to the all-time high of 2.22 million in 2018-19.

There are other indicators that suggest a demand problem. The RBI’s current consumer confidence index has had a largely downward trend for almost the last five years. And things have only gotten much worse with Covid. The level of the current confidence index in May 2021 was around half of where it was in May 2019.

This is also reflected in the fact that people have more cash in hand currently than they ever did. As of March 2021, the ratio of currency in circulation to GDP stood at 14.5%, the highest in half a century. It was at 12% of GDP in 2019-20. This tells us that people are holding on to money and not looking to spend it. The reasons may vary – fear of another wave of Covid; uncertainty whether their income will stay at current levels or whether they might suffer pay cuts or even lose their jobs. In this situation, people are trying to stay prepared for the future by keeping money in hand, rather than spending.

The point is, India has a major demand problem. The government has been trying to address it for a while now. In September 2019, it cut the base corporate tax rate from 30% to 22%. The idea was that lower tax rates would incentivise companies to expand their operations. That would create jobs. Jobs would mean incomes, which people would spend and thus fuel economic growth.

The government has also offered loan guarantees to encourage banks to lend to industry. Between 2019-20 and 2020-21, bank lending to medium industry -- defined as firms with investment in plant and machinery or equipment of up to Rs 50 crore and a turnover of below Rs 250 crore – rose by 28.8%. While this sounds impressive, it was on a small base. In absolute terms, bank lending to medium industry rose from Rs 1.06 lakh crore to Rs 1.36 lakh crore. Also, the overall lending to industry rose by just 0.44% in 2020-21.

In fact, this isn’t just a one-year phenomenon. Bank lending to industry over the last five years has risen at the rate of just 1.33% per year. This, despite the fact that interest rates have come down dramatically in the last two to three years.

One reason for this lies in the fact that the capacity utilisation of Indian industry has been falling. Data from the Reserve Bank of India tells us that it peaked at 83.2% in March 2011 and since then has seen a largely downward trend. It was at 76.1% in March 2019, falling to 69.9% in March 2020, even before the negative economic impact of Covid had set in. It was at 66.6% in December 2020.

Basically, Indian industry on the whole has enough capacity currently and has no need to expand unless demand goes up dramatically. As the economist Nitin Desai put it in a recent column in the Business Standard: “Investment is a derived demand, and it will not rise till final demand rises.” This is reflected in the investment-to-GDP ratio, which has fallen from a peak of 35.81% in 2007-8 to a 20-year low of 27.09% in 2020-21.

The point is, the government and the RBI are trying to drive up investment in the economy, which is at best a long-term solution. But the long-term solution won’t kick in unless demand goes up in the short term. In order to do that, more money needs to be put in the hands of people, or the prices of things have to fall. Take the case of two-wheelers and cars: Sales can easily be boosted by cutting the GST rate on them. The multiplier effect of doing so would be huge given that everything from steel to rubber to plastic goes into the making of two-wheelers.

The government could also look at easing the income tax rate. While a very small portion of the population pays income tax, remember that it is this section of the household economy which still has decent purchasing power.

In short, India has a demand problem, which cannot be set right by trying to fix the supply side.