There is a gigantic question mark hanging over the economic recovery and the growth trajectory of India, right now. The International Monetary Fund (IMF) recently downgraded its growth forecast for FY21/22 (April 2021 to March 2022) to 9.5% from the previous 12.5%. This is same as the Reserve Bank of India’s (RBI) forecast of 9.5%, which is almost the middle of the range of growth forecasts available for India. While these numbers can be very informative for the financial markets and the participants thereof, the society at large can get confused by these numbers and their meaning.
Here we deconstruct the growth outlook of India, analyzing the challenges (structural or pandemic related) and tailwinds (growth boosters) in the ongoing financial year (FY21/22). First things first though, the primary way to assess growth is to look at the Gross Domestic Product or GDP. GDP is the market value of all the finished goods and services produced within the borders of a country in a specific time period. When economists talk of growth they usually refer to real GDP growth where real implies ‘adjusted for inflation’ in the economy. Thus, real GDP equals GDP growth less inflation rate in the economy. While there are three different ways to estimate GDP, we will just focus on the ‘expenditure method’, which divides the GDP into private consumption, government consumption, investment and net exports (exports minus imports). This captures the total output of the economy through the lens of total spending by different participants in the economy.
Private consumption is weak
The pandemic has had a ruinous impact on consumption capacity of the households. While the accessibility to shops became a problem in the face of restrictions on movement (to control the virus outbreak), one has to remember that consumer spending was already slowing down even before the pandemic started. Incomes in India had largely stagnated with increasing number of workers finding employment in jobs of lower quality. This process has gained speed as the lockdown implemented last year to manage the pandemic severely impacted the medium, small and micro businesses (MSMEs), which employed close to a quarter of the total labour force in India (people looking to work). Consequently, the number of workers who are self-employed have risen as has the number of workers with no social security (economists call them as informal workers). Needless to say, these are typically at the bottom of the income pyramid. But more on this later.
Also, the RBI’s consumer confidence index for urban areas is at a historically lowest level. The situation is not good even in the rural areas. While agriculture sector has done well, incomes in rest of the occupations (construction workers, blacksmith etc) have declined rapidly. Lower incomes translate into lower consumption of discretionary/non-essential items like cars, scooters, televisions, mobiles etc. For instance, sales of two-wheelers (a good indicator of rural consumption) have been falling. The RBI’s consumer confidence survey results also point to very weak demand for discretionary/non-essential items.
These developments imply that households are not very willing to spend at the moment, which has serious implications for the demand of goods and services being produced in India and thus the business community at large, which in turn would again depress incomes. This is a vicious circle.
Government consumption should support growth
This component comprises of government’s spending on payroll of its employees and purchase of goods and services (not a part of capital formation or investment). It strengthened in the last fiscal year (April 2020 to March 2021), supporting overall output growth. Economists expect it to remain a major driver of growth in FY21/22 as well through a variety of its programs like NREGA and/or consumption incentives for its employees, amongst others.
Investment or gross fixed capital formation (GFCF) to be driven by the government
This consists of spending on ‘capital formation’ or simply factories, roads, ports etc. It can be both private and public (government and state entities). While private investment averaged around 25% of total output (GDP) during 2004-05 to 2015-16, public investment averaged 8%-8.5% during the same period.
In the current environment, private businesses and households (who invest in making houses) have a reduced appetite for undertaking new investment projects. This is because of the high uncertainty about future growth given possibility of new virus outbreaks. Businesses are reluctant to invest in new capacity (building offices or factories) as they are already functioning below capacity due to weak consumer demand (as discussed above). Interestingly, capacity utilization had been falling for businesses (output being produced was below the total output that could be produced using the factories) even before the pandemic because the consumer demand was declining, as we discussed earlier.
Therefore, the government has taken up the responsibility to invest in infrastructure during these troubled times. The capital expenditure by the government has been strong in the last few months, barring the time of the second wave of COVID-19. Given the mandate of the FY21/22 Union Budget, the government should remain committed to spending on infrastructure this fiscal year.
Net exports to be a positive contributor
Exports (inflow of money for India) less imports (outflow of money for India) of goods and services typically either contributes negatively to growth or in case the contribution is positive, it is usually very marginal. In FY20/21 however, the contribution was positive and very large as exports recovered faster than imports. Imports have been weak on account of lower private consumption (lower demand for goods and services) and investment activity. Going forward, it is expected that imports will improve as government’s investment plans materialize (import of machinery) and consumer demand normalizes somewhat. Also, exports are likely to expand due to strong growth outlook for the US and European advanced economies. Thus, net exports should contribute positively, although it will be small as it typically is.
Structural Weaknesses continue to weaken growth
Now that we have discussed the components of GDP and their expected trajectory in the near future, we move on to the more pressing discussion of structural weaknesses in India. As mentioned before, growth in India was already slowing down before the pandemic, falling from 6.8% in FY17/18 (April 2017 to March 2018) to 4.0% in FY19/20.
One of the most cited reasons/drivers of this weakness has been the stressed financial sector. To put it simply, the banks and non-banking financial companies (NBFCs) accumulated increased share of ‘bad’ assets, like loans that cannot be repaid by businesses. These impaired the ability of the banks to lend money to people and businesses. Consequently, operations of businesses suffered due to lack of availability of capital causing incomes of workers to stagnate and falling consumption. The pandemic may have worsened this issue as a lot of MSMEs have lost their revenue sources (with demand falling for their goods or because they ran out of money to operate during extended periods of lockdowns) and their loan paying ability has deteriorated.
The second weakness has been growth without creation of quality jobs (phenomenon economists refer to as jobless growth). By quality, we imply lack of social security benefits and/or increased opportunities to earn more by improving capabilities. Here one can think of vegetable vendors, paanwalas and chaiwalas (self-employed category) or else salespersons in neighbourhood shops, peons and clerks in MSMEs, maids (informally employed with regular salary but no EPF or medical benefits). The share of such employment has risen in last few years for the lack of better and formal jobs (jobs with social security benefits). This has also dampened the consumption and consequently the overall domestic activity in the country. The pandemic has just worsened the situation with more joining the ranks of informal workers.
These two most important weaknesses have worked to, and are still working to, lower the overall potential of the Indian economy to grow in the future. Even if India manages to achieve 9.5% growth this fiscal year (FY21/22), it will lag other emerging economies in next few years if it doesn’t address the above two weaknesses and other challenges like endemic corruption due to inherent weaknesses in processes and organization of government activity, low quality and inadequate infrastructure and lastly, extremely low human capital development – quality education at both school and college levels and quality health care.
Disclaimer ; Views expressed above are the author's own