Making the correct trade-offs can support higher growth over the long term as can implementing a foundational reform agenda
Source Image: Getty
India is at an inflection point. Realising our long-dormant economic potential is happening faster than our institutions are adapting to the new challenges that accompany such growth. Becoming the fastest-growing large economy this year with an unanticipated GDP boost of around 0.7 percentage points above our long-term growth rate of 6.6 percent, and reducing unemployment, including for women, signals that the future might have arrived. In such happy circumstances, it is normal for economies to continue doing what has worked earlier, lest the delicate balance of economic forces producing high growth gets disrupted.
Becoming the fastest-growing large economy this year with an unanticipated GDP boost of around 0.7 percentage points above our long-term growth rate of 6.6 percent, and reducing unemployment, including for women, signals that the future might have arrived.
The government is departing from past practice on two counts: First, continued reliance on public finance-led growth departs from the earlier consensus that private investment (domestic and foreign) must do the heavy lifting in a resource-constrained democracy, with high public expectations of welfare support. Second, the assessment that 7-percent plus growth is a certainty despite the dismal global economic outlook.
Over the near term, globally, in the West and the East, second-rung economies—Europe, India, Bangladesh, and Southeast Asia—pack the growth punch. The International Monetary Fund (IMF) expects average growth from 2023 to 2025 to slow from 5.4 percent to 4.8 percent in emerging Asian economies, primarily because of the growth slowdown in China—yesterday’s growth driver—from 5.2 to 4.1 percent of GDP. Advanced economies will recover slowly from 1.6 to 1.8 percent over the same period, clouded by growth declining in the United States (US) from 2.5 to 1.8 percent.
To buck the unsupportive trend in the global economy, India has adopted the public finance and industrial regulation-led growth model, favoured by the advanced economies presently. Total public debt (Union and state governments) is already up from 69.6 percent of GDP in 2017-18 to 86.5 percent of GDP in 2022-23 and increasing, versus the norm of 60 percent of GDP. Unlike in the advanced economies, stimulus spending in India is sticky, particularly welfare spending to boost incomes and consumption, which increases the resource constraint. The number of programmes funded by the Union government increased from 73 in 2017-18 to 173 in the Union Interim Budget 2024-25. Total government expenditure (union and states) increased from 17 percent in 2017-18 to 19 percent of current GDP in 2022-23.
Unlike in the advanced economies, stimulus spending in India is sticky, particularly welfare spending to boost incomes and consumption, which increases the resource constraint.
Significant corporate concessions—slashing tax from 30 to 22 percent with an even lower 15 percent tax for new companies incorporated till 2024—were given in 2019-20. The incentive tax rate for new companies has not been extended in the Interim Budget but the main budget might do so. The scope for further tax rebates is limited because of the growing fiscal pressure of the extensive web of welfare programmes, which are the glue for cross-regional, cross-caste support for the ruling government. Subsidy payments on food, fuel, fertilisers paid from the Union Budget are 1.2 percent of GDP at INR 4.1 trillion and account for 8.6 percent of total expenditure. Indirect subsidies for public transport (rail and road) and utilities (water and electricity) drain government-owned supply agencies while industrial subsidies drain Union government-owned banks.
Continued reliance on a debt-based, public spending, growth model, is visible in the protracted phase-down of the fiscal stimulus. Contrary to popular perception, fiscal stress existed even prior to the COVID-19 epidemic of 2020-21. In 2019-20, the fiscal deficit (FD) reversed the gains made over the earlier five years when FD reduced from 4.5 percent in 2013-14, where the United Progressive Alliance (UPA) government had left it, to 3.4 percent in 2018-19. Some of this reduction was illusionary. Finance Minister Sitharaman made a fresh start in 2019-20 by unravelling the smart accounting practices disguising the true size of the FD, swelling it to 4.6 percent of GDP in 2019-20—a tad higher than in 2013-14. The succeeding year 2020-21, the COVID-19 economic disruption pushed FD to 9.2 percent of GDP. The return to the norm of 4 percent of GDP from a projected FD of 5.8 percent in 2024-25 is planned to take till 2026-27—a full seven years after FD crossed the norm of 4 percent in 2019-20.
Protracted, soft budget constraints supported by government borrowing rather than the hard options of tax mobilisation or generation of non-tax revenue by monetising public assets and privatising state-owned industrial entities and banks, risks a less efficient use of capital and thereby drives inflation.
Growth in the next two fiscal years will be driven by public investment. Tracking the Incremental Capital Output Ratio—a metric which red flags potential investment inefficiencies—should become routine for good practice public expenditure management. Protracted, soft budget constraints supported by government borrowing rather than the hard options of tax mobilisation or generation of non-tax revenue by monetising public assets and privatising state-owned industrial entities and banks, risks a less efficient use of capital and thereby drives inflation.
Retail inflation was at 5.69 percent in December 2023 with food inflation at 9.53 percent. The RBI expects inflation to trend downwards, but admits that at 4.75 percent in the third quarter of 2024-25, it is “ quite some distance away” from the norm of 4 percent and “perilously close to 5 percent”. Consequently, the 6.5 percent “disinflationary” policy repo rate determined in February 2023 continues. A return to an accommodative policy stance awaits signals, possibly by 2025-26, that inflationary pressures have receded.
The economy is expected to grow at 7.3 percent (NSO) in 2023-24 and the expectation for next fiscal year is 7 percent (RBI). Puzzlingly, the Interim Budget 2024-25 takes a much more cautious view pegging real growth, implicitly, at just 5.8 percent (nominal GDP growth of 10.5 percent less expected inflation at 4.7 percent). The IMF estimates 6.7 percent real growth in 2023-24 and 6.5 percent next fiscal. FM Sitharaman might have characteristically adopted a conservative, nominal GDP growth rate, to avoid overreach in tax and revenue targets, which are linked to growth assumptions. Continuing inflation, well above the norm over the next two years, with continuing high, deflationary interest rates, presents a challenge for growth. The private sector’s “animal spirits” will respond only if the high growth expectations are realised.
India is likely to enjoy the benefits of political stability in the foreseeable future, which derisks private investment—particularly foreign investment—from democratic turnabouts. This can help bring to market cutting-edge technology presently at the demonstration stage in artificial intelligence, space, defence equipment, battery storage, green hydrogen, carbon sequestering, low carbon construction and design, second and third-generation (cellulosic and algae) based biofuels which, unlike food crops-based biofuels, are not water and land intensive and do not compete with food production.
There is a trade-off between scaling up affordable new homes and the higher initial cost of carbon emission efficient urban design.
None of this is easy or cheap, not least because of political-economy trade-offs. For example, balancing the consumption needs of the growing, predominantly urban, middle class (about 400 million strong earning between INR 0.05 to 3 million annually) with the dreams of the aspiring classes (about 750 million population) for cheap and safe transport and housing. Or metros with electric buses for last-mile connectivity in cities and better inter-city rail connectivity benefit the aspiring masses. Pouring concrete to build and widen roads and highways for the 340 million privately-owned road vehicles, with 20 million added every year, are middle class favourites. Similarly, there is a trade-off between scaling up affordable new homes and the higher initial cost of carbon emission efficient urban design.
Making the correct trade-offs can support higher growth over the long term as can implementing a foundational reform agenda. The Union government must step back from direct programmatic intervention. Its core sovereign functions are daunting enough. The government must give the private sector more economic elbow room via large scale privatisation, public financial support for private sector growth and data driven, light-handed regulation of markets. Doing less and delegating more can be astonishingly productive.
Sanjeev Ahluwalia is an Advisor at the Observer Research Foundation
The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.
Sanjeev S. Ahluwalia has core skills in institutional analysis, energy and economic regulation and public financial management backed by eight years of project management experience ...
Read More +
PREV
