Good GDP numbers hide many fault lines

Structural reforms are necessary to sustain India’s high growth trajectory and enable the nation to achieve developed country status by 2047

The Reserve Bank of India (RBI), in its monetary policy statement on October 6, 2023, has reiterated that the economy will register Gross Domestic Product (GDP) growth of 6.5% this year though it is expected to decelerate from 7.8% in the first quarter to 5.7% in the fourth. Other estimates by the rating agencies and multilateral banks are quite close to this estimate with the International Monetary Fund (IMF) and the World Bank projecting 6.3% and the Asian Development Bank keeping it at 6.4%. Although lower than last year’s 7.2% growth, the numbers are impressive: India continues to be the fastest-growing large economy in the world.

Currently, GDP growth is led predominantly by private consumption and public investment.(Representative image)

However, it would be too early to be euphoric. The Prime Minister would like to see India as a developed economy by the centenary year of Independence (2047), which, according to the World Bank definition, requires the economy to achieve a per capita income level of $13,205. The task is challenging as the economy will have to register an average annual growth of 8-9% over the next 20 years to achieve this.

Significant structural reforms need to be undertaken to achieve this aspirational target. Although the risks to growth are evenly balanced in the Reserve Bank of India (RBI)’s assessment, a closer look at the economic outlook shows that the risks seem to weigh more on the negative side.

Equally important is the challenge of accelerating and sustaining growth in the medium- and long-term to address the structural problems, particularly reversing the decelerating trend in savings and investment. The poor monsoon this year is likely to adversely impact incomes from the agricultural sector and agro-processing industries and may dampen rural demand. In the medium-term, the decelerating supply of the household sector’s financial savings coupled with the continued draft on it by the government due to very high levels of fiscal deficit, are unlikely to spur private sector investments in the medium-term.

On average, the agricultural sector has been growing in the recent past at about 4%. However, a monsoon deficit of 5.6% from the long-period average this year is likely to impact the sector adversely. The RBI governor’s statement says that despite the deficit, the acreage under kharif (monsoon crop) cultivation is higher by 2%. However, wide variations in the temporal and regional spreads of the monsoon are likely to lower productivity, particularly in water-intensive crops. Besides, the acreage under cultivation of pulses is estimated to be lower by 4.9% and that will impact both outputs and prices. The significantly lower levels in reservoirs are also likely to have an adverse impact on the rabi (winter crop) output.

The manufacturing sector too is unlikely to show any stellar performance. Although the non-agricultural credit growth is high, the spike in personal credit, particularly for housing and vehicles, constitutes a substantial part of this. The services sector including public administration, defence, and other services is likely to perform well as elections are scheduled for five states in this financial year and the general election to Lok Sabha is likely to be held in early 2024. The PMI of both industry and services has continued to expand, but it remains to be seen whether the momentum will be maintained throughout the year.

The global slowdown, the protectionist trend in advanced Western countries, and international conflict situations are other factors dampening external demand. Even if in the current year the economy registers a growth of 6%, it will be high in the context of slower growth in most countries. Accelerating growth and sustaining it at about 8-9% to reach the status of a developed country by 2047, requires considerable reforms that must be implemented without much loss of time. Spurring domestic demand alone has not been adequate to accelerate and sustain high growth in any country that has experienced high growth over long periods of time: Most of them had to depend upon increasing exports to maintain the growth momentum. Competitiveness cannot be achieved by maintaining high levels of tariffs. Achieving competitive manufacturing requires undertaking domestic reforms, however difficult they are. Small firms account for over 75% of manufacturing employment. But with no incentive for them to grow and achieve an optimal economic size and scale, their competitiveness is lost. In fact, there are significant disincentives for the small to become medium and large. According to an OECD report, 77.6% of the persons in the age group of 25-64 years have education levels below the upper secondary level and even training them is going to be a challenge. The medium-term risks to growth are even more serious.

Currently, GDP growth is led predominantly by private consumption and public investment. Much of the household consumption has been financed by borrowings from financial institutions: The household sector’s financial savings as a ratio of GDP has shown a sharp decline to 5.1% in 2022-23 from 7.2% in the previous year. With a high fiscal deficit, there is hardly any borrowing space left for private investment. This is driving up the cost of borrowing. The decelerating levels of saving and investment can pose a major constraint in accelerating growth. Besides, attempts at fiscal consolidation will constrain the ability of the government to increase public investments. At the same time, a global slowdown, geopolitical tensions, and wars along with a protectionist policy environment do not show high prospects for growth acceleration through exports. In this environment, serious structural reforms to increase savings and investment, compress the fiscal deficit at the Union and state levels to ensure adequate availability of borrowing space to the private sector, and open up the economy and enhance competitiveness in Indian manufacturing are imperative. The challenge of achieving developed country status by 2047 is formidable but not impossible if such reforms are initiated.

M Govinda Rao is a former director, NIPFP, and member, Fourteenth Finance Commission. The views expressed are personal