Growth is slowing in India. In July to September this year there were six major economies -- Malaysia, Greece, the Philippines, Israel, Colombia and Argentina (The Economist) with growth higher than the 6.3 per cent which India achieved in the April to September quarter of this fiscal. Growth by the yearend is unlikely to be vastly different. Is this catastrophic? Not really, because the key metric today is not just growth but growth with macroeconomic stability. Colombia and Argentina do not score well on this count.
Taming inflation remains a global priority. So concerned is the Federal Reserve of the United States that it is willing to risk a serious downturn to stamp out inflation running at 7.7 per cent (albeit down a bit from 8.1 per cent). The belief is that dragging out the adjustment embeds inflation expectations permanently with even worse effects, so it may be best to take the pain now.
India cannot afford to be that fundamentalist. Trade-offs exist between protecting nascent growth with lower interest rates and yet managing consumer inflation, which is higher than the permissible range of two to six per cent but declined from 7.41 per cent in September to 6.77 per cent in October 2022. Also, unlike the US, inflation is significantly supply side driven and not by wage growth.
Employment in India remains tepid, unemployment is at eight per cent, with young workers and women facing the worst outcomes. The crucial manufacturing sector is just five per cent above 2019 levels. Construction remains at four per cent below (H1 Gross Value Addition basic, constant prices).
At 6.25 per cent, the repo rate, at which the Reserve Bank lends to banks, remains negative versus inflation at 6.7 per cent, the consequence of a surge of cheap money unleashed during the Covid-19 pandemic, which is one factor driving inflation. The prudent choice for India is to trail the hardening US interest rates to signal our commitment to bear the pain of taming inflation but follow at a relaxed pace with an eye to growth.
The fastest way to cool inflation would be lower indirect taxes (GST and import duties) which are regressive anyway, as they don’t discriminate between low-income individuals suffering on the downward sloping arm of the K-shaped post-pandemic growth revival and the few others who are progressing happily along the upward sloping arm -- going up a hill could never have been this pleasurable! Targeted rationalisation of tax rates does wonders as illustrated by our performance in corporate tax. Despite effective rate reductions, revenues during April to October are 24 per cent above the same period last year.
Versus the Budget estimate of 11.1 per cent growth in current terms, the outcome in H1 is 15.5 per cent (real growth rate at nine per cent plus inflation at 6.49 per cent). Tax revenues, however, increased at 18 per cent despite the loss of Rs 390 billion due to the partial rollback in excise tax on fuel -- to lower inflation and give income support to commuters. The continuing healthy revenue collections augurs well for similar tax rationalisations in the upcoming Budget giving relief to the average consumer and lowering inflation whilst tapping financially resilient pools of income for additional revenue. Revenue accretions could, however, slow in the second half this fiscal as the nominal growth rate slows to 12.5 per cent (real growth six per cent and inflation 6.5 per cent).
Capital investment has improved at 34.7 per cent of constant GDP in H1 2022-23 higher than the 33.1 per cent in H1 previous year and 31.9 per cent in H1 of 2019-20. The catch is that much of the increase is due to enhanced capital spending by the Union and state governments.
Maintaining this elevated public spending level in the absence of high growth (7.5 to eight per cent) clashes with the need to taper down the fiscal deficit from 6.4 per cent to four per cent over the next five years. Note also that elevated fiscal deficit levels feed domestic demand which means higher imports, enlarging the current accounts deficit.
A persistent, high current account deficit is India’s Achilles heel courtesy pervasive export pessimism. Fuel, electronics, gold and gems, machinery, chemicals, edible oil, resins and plastics and non-ferrous metals comprise 75 per cent of our imports -- reflecting poor natural resource endowments and inadequate process and product R&D in manufacturing. Merchandise (goods) exports grew by 2.5 per cent points of GDP between 2019-20 to 2022-23 (first half). With domestic economic activity also increasing, imports grew faster at 5.6 per cent points of GDP, widening the current account deficit.
Over the next two years balancing the current account deficit seems unlikely. Export growth faces the headwinds of low overseas demand and domestic hesitation in opening the economy to import competition via free trade agreements. Nevertheless, enhanced gains in services trade are possible with canny positioning and negotiation. Exports should become a national priority and domestic price stability improved by stocking or importing sensitive consumption items like food or fuel to moderate inflation spikes. Lowering logistical and transaction costs for exports was never as important as today.
The big challenge in growth is to avoid a relapse to the four per cent growth rate in the pre-pandemic last quarter of 2019-20. Continuing targeted welfare assistance till growth revives and inflation abates will not only provide social protection but also boost consumption demand in the interim.
Once growth exceeds 6.5 per cent per year. the additional fiscal space created can be used to cut back the fiscal deficit and lower the current account deficit.
It is never too early to explore more intrusive management measures to improve the efficiency of public expenditure. Just shovelling more money out of the door without relating expenditure to outputs and outcomes is expensive. Budget reform must enable doing more with less, cut waste, improve project execution, and control administrative expenditure.
The government now has a Capacity Development Commission. Its mandate should be expanded beyond training and skills development to administrative reform functions like retooling and redesigning government systems. The commission’s performance should be measured in systems efficiency enhancement metrics not just the number of training programs conducted.
It is telling that the narrative in the recent elections in Gujarat, Himachal Pradesh and the municipal elections in Delhi reflected unabashed clientelist populism -- customised welfare takeaways in exchange for votes. Suspended in public disbelief is the grim reality of an economy caught between the rock of a downward fiscal pull of misallocated subsidies and an unsupportive global economic environment. This may prove expensive, even in the short term.