Expect a mild slowing down of the economy in the coming year

The Indian economy grew at a rate of 7.2 percent during last fiscal year, i.e. from April 2022 till March 2023. At that time the forecast from both the International Monetary Fund (IMF) and the World Bank was that India will further slow down this fiscal year to around 7 percent. This view is still shared by the Reserve Bank of India as per their latest assessment.

However, quite surprisingly, the momentum for the first six months of this fiscal year has been tremendous. That is why the growth rate for the first half of the fiscal year of 2023-24 is an impressive 7.7 percent, much higher than the IMF and World Bank estimates. It was driven largely by a 31 percent growth (in nominal, inflation unadjusted terms) in the capital expenditure, both by government and the private sector.  This strong rate of capex push, largely by the government, was far more than the 11 percent pace seen the previous year. Since capex is about one third of the GDP, and if that part grows at 31 percent, surely the aggregate GDP growth gets a strong impetus. Thus, the pace of the first half defies both the international agencies and even the cautious optimism of the RBI.

Clearly the second half of this fiscal year, from October till March is a slowdown phase

Now the government has published its advance estimates for the full year, which is 7.3 percent. This implies that during the second half the government expects growth to slow down from 7.7 in the first half, to around 6.9 during the second half, giving an average of 7.3. This number is still quite impressive and is above RBI’s estimates. Is it too optimistic? We will soon find out. The extrapolation is based on detailed data points (called “high frequency data”) available to the government. This includes tax collection including GST, movement of cargo, tourist arrivals, export data, oil and energy consumption trend and so on. 

The geopolitical flashpoints cast a dark cloud, and make investors generally risk averse

However, nobody knows how quickly the momentum can slow down. The best of economists are not really expert psychologists, for ultimately it is consumer and investor psychology and sentiment which drives growth.  This present fiscal year, consumption growth is growing only at 4.4 percent, i.e. below GDP growth rate and far below the capex growth rate. Consumption spending is more than 60 percent of the GDP and forms the bulk of the momentum.  That in turn depends on how household incomes are growing, what are the prospects for employment growth and livelihoods and so on.

As we get into the model code of conduct period, inevitably it puts a brake on developmental spending

So clearly the second half of this fiscal year, from October till March is a slowdown phase, as per the government’s own projection. This is also partly because the government funded fiscal push to capex cannot continue indefinitely. It hurts the fiscal deficit, which if not kept under control can make the debt to GDP ratio rise to 100 percent, as has been warned by the IMF. Hence if the government itself tightens its purse strings then the growth momentum has to come from somewhere else.

The situation in India is not immune to what is happening in the rest of the world. Globally there is a talk of recession in most advanced economies.  The geopolitical flashpoints cast a dark cloud, and make investors generally risk averse. The Ukraine war is two years old with no end in sight. The Israel-Palestine conflict is threatening to spill out in a larger region of the Middle East. More worrying are the attacks by the Houthi faction on commercial ships traversing the Red Sea. Many commercial cargo and passenger liners will simply avoid using this channel which normally hosts more than half the global trade traffic. Any geopolitical flashpoint, especially in the Middle East has the potential to spike up the oil prices, which is very bad news for India. It has negative consequences for inflation, the fiscal deficit, consumer and investor sentiment, and ultimately growth.

The other factor apart from global geopolitics which can affect the growth outlook, is the national election in India. As we get into the model code of conduct period, inevitably it puts a brake on developmental spending. Apart from the Lok Sabha, there are many States too which are scheduled for elections to their respective State legislatures.  Election year does provide a small fiscal push to the economy, and the incumbent government fast tracks pending projects, clears many more files, fills up vacancies in government jobs and so on. All of this is a positive for the economy, even if fiscally doubtful.  

The acceleration of spending now, in a pre-election spending spree, means post elections (after July) we may see a moderation in the spending momentum. Of course, the incumbent government might not choose to accelerate spending now, if it feels that its re-election prospects do not depend on artificially inserting fiscal steroids for now!

The positives for the economic outlook are the strong structural factors. These include a youthful demography and expanding labour force, rapid urbanisation, increasing spending on the green economy and the large infrastructure ambition.  On top of this is the continuing strong momentum in the export of software services.  The negatives are as mentioned earlier, weak consumer spending, global uncertainties, potential for an oil spike, still high inflation and weak employment growth prospects.  

The growth in real wages at the lower end, especially in agriculture, rural areas and the informal sector has been very low

It must be noted that overall consumer spending will pick up when consumers from all income classes are doing well, in terms of their wage income growth and employment prospects. Hence if the lower income classes are not doing well it is a matter of concern. This is the continuing story of the K-shape trajectory of growth, where consumers in the higher income bracket, and those who buy higher priced products and services and luxury goods are doing very well, but those in the lower classes are struggling. The growth in real wages at the lower end, especially in agriculture, rural areas and the informal sector has been very low. This is a serious policy challenge. The extension of the free food scheme for five years for 800 million Indians is a partial response to compensating for their lack of income growth.  In the longer term, for high growth to be sustainable it also has to be wider and more inclusive.  On the balance we can expect growth to be lower in 2024-25 than during this fiscal year.