India is at an inflection point. Realizing our long dormant economic potential is happening faster than our institutions are adapting to the new challenges. Becoming the fastest growing large economy this year with an unanticipated GDP boost of around 0.7 percentage point above our long-term growth rate of 6.6 percent over the past three decades and reducing unemployment, including for women, signals 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.
A daring vision: Growth is a given, borrow and spend.
The Modi government, at the end of its second term, 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.
Second rung economies deliver the growth punch.
Over the near term globally, in the West and the East, second rung economies- in Europe, India, Bangladesh and South East Asia pack the growth punch. The 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 growth slowdown in China -yesterday’s growth driver -from 5.2 to 4.1 percent of GDP. Advanced economies recover slowly from 1.6 to 1.8 percent over the same period, clouded by growth declining in the United States from 2.5 to 1.8 percent.
“Big governments” struggle with sustainable growth.
To buck the unsupportive trend in the global economy, India has adopted the public finance and industrial regulation (import protection) led growth model favored 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 programs 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
Exemptions constrain direct tax growth.
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 programs which are the glue for cross-regional, cross-caste support for the ruling Bhartiya Janta Party. Subsidy payments on food, fuel, fertilizers paid from the Union budget are 1.2 percent of GDP at Rs 4.1 trillion 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.
High deficits over prolonged periods embed fiscal risk.
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 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.
Soft budget constraints do not square with efficient capital allocation.
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 mobilization or generation of non-tax revenue by monetizing public assets and privatizing 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 growth illusion
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 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, present a challenge for growth. Private sector “animal spirits” will respond only if the high growth expectations are realized.
Private investment in cutting-edge technology.
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, electrification of industrial heat and process decarbonization in steel and cement, low carbon construction and design, second and third generation (cellulosic and algae) based biofuels
Navigating trade offs
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 Rs 0.05 to 3 million annually) with the dreams of the aspiring classes (about 750 million population) for cheap and safe transport and housing. 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 favorites. 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. Give the private sector more economic elbow room via large scale privatization, public financial support for private sector growth and data driven, light-handed regulation of markets. Doing less and delegating more can be astonishingly productive.
Opinion India 