Contraction in demand, profits to test govt’s mettle

IN less than three weeks, we will have a new government in New Delhi. If the opinion polls have got it right, Narendra Modi will get a third term as Prime Minister. Indeed, the PM is so confident that he has already set tasks for his babus that have to be completed within the first 100 days. Whoever wins, the next two years are not going to be easy. And the reasons for that lie in the structure of our economy, specifically the way income has got distributed between social groups in the past five years.

The Centre for Monitoring Indian Economy’s count of more than 33,000 companies shows that between 2013-14 and 2018-19 — the first term of the Modi regime — total sales of the corporate sector grew at an average annual rate of 9.5 per cent, which works out to about 5 per cent if you adjust for inflation. Profit after tax actually decreased at an annual rate of 2 per cent, or by a massive 6.5 per cent in real terms. During the same period, the total wage bill increased at 14 per cent per year in nominal terms and 9.5 per cent in real terms.

So, owners of capital saw their returns shrink, while they had to pay more to their employees. Anecdotal evidence tells us that most of this extra expenditure on salaries and wages would have been cornered by the top 10 per cent of earners in any company — the cream of the white-collar segment. This is borne out by the income estimates made by the Paris-based World Inequality Database (WID). It suggests that the richest 1 per cent saw their real income grow at the rate of 3.8 per cent per year during PM Modi’s first term, while those in the next 9 per cent, in terms of income, did marginally better, with their real income rising at 4.3 per cent per year.

The slowest income growth happened for those between the 50th and 90th percentile, with those in the 80-90 per cent bracket seeing the lowest growth of just 1.9 per cent in real terms. This explains why most corporates found it difficult to make money. They couldn’t really expand beyond the top 10 per cent of earners, as the middle-income groups barely witnessed any improvement in their ability to spend.

Then, how did Modi retain power in 2019? The answer is clear when you look at the income growth of the poorest 30 per cent of Indians, whose real income grew at a decent 3.9 per cent per year, exactly the same as that of the top 10 per cent of the earners. On the other hand, the average real income growth in the 50-90 per cent bracket was just 2.4 per cent. So, both the rich and the poor had reason to vote for the BJP, while the middle class had reason to hope for achhe din.

When the BJP began its second term, it immediately decided to solve the problem of corporate profits by cutting taxes. During Modi’s first term, profits before tax rose at 5.5 per cent annually, while tax provisions increased at more than twice that rate. Between 2019-20 and 2022-23 — the three years for which we have comparable data — profit before tax increased at 29 per cent per year, while tax provisions increased by just one-third that rate. The net result was that post-tax profits for India’s corporate sector increased at an incredible rate of 45 per cent per year in the first four years of Modi 2.0.

The wage bill, on the other hand, increased by less than 11 per cent annually, and just 5.5 per cent if adjusted for inflation. Anecdotally, we know that middle management salaries have not increased much in the past few years, while that of top management have shot up. This again is backed by the WID’s income distribution estimates. The richest 1 per cent of earners had an average inflation-adjusted real income growth of 4.4 per cent per year between 2019 and 2022, which was better than how they fared between 2014 and 2019. The next 9 per cent, however, have seen their real income growth collapse to just 1.9 per cent per year, less than half the growth they experienced in the Modi government’s first term.

Again, the bottom 30 per cent have seen a decent 4.2 per cent annual real income growth, with the poorest 10 per cent’s real income growing at 5.5 per cent per year. Those in the 50-90 per cent bracket have done even worse than before. Their real income grew at just 2.2 per cent annually in the first three years of Modi 2.0. This is why the premium segments of the economy have grown very fast, while companies that cater to wider markets have stagnated.

Till now, corporate profits have boomed, even though sales have not kept pace with GDP growth, because of lower financing costs and taxes. This process is now gradually coming to a close. While sales are inching forward at a snail’s pace, profits have also started to stagnate. Around 1,100 listed companies have declared their results for the first quarter of 2024 — their net profit has grown by just 1.8 per cent compared to last year. The situation is worse for non-financial companies among them; their profit has fallen by 7.6 per cent.

Any new government will have to deal with this contraction in demand and profits. It is not going to be easy, because there is not much leeway available to cut taxes or reduce interest rates significantly. If things don’t improve for India Inc and the richest 10 per cent, they will get restive. The spurt in premium real estate sales will peter out. The corporate-controlled sections of the media will start voicing their reservations about government policies, and public opinion will begin to shift. This is what happened to the UPA within a year of retaining power in 2009. The next government will have to find a strategy to avoid that fate.

The author is a senior economic analyst