India's economic recovery is real, but uncertain, and faces an array of challenges. Can it overcome?

On August 1, while addressing the Rajya Sabha on inflation, Finance Minister Nirmala Sitharaman declared that despite adversities, India remains the world’s fastest-growing major economy. The applause in Parliament that followed does ring true, but what is also true is that the country’s $3.1-trillion economy and 1.3-billion population were sucker-punched by the consecutive waves of Covid-19. The extent of the damage finds mention in RBI’s report titled Scars of the Pandemic. Here’s a peek. The output losses for individual years have been worked out to Rs 19.1 lakh crore, Rs 17.1 lakh crore and Rs 16.4 lakh crore for FY21, FY22 and FY23, respectively. Taking the actual GDP growth rate of (-) 6.6 per cent for FY21, 8.9 per cent for FY22, and assuming growth rate of 7.2 per cent for FY23 and 7.5 per cent beyond that, the report mentions that India is expected to overcome Covid-19 losses only by FY35.

Sounds frighteningly long? Yes, but the good news is that some early signs of economic recovery are clearly visible. In July, GST collections were at Rs 1.49 lakh crore, the second-highest ever; credit offtake was at a robust 14.5 per cent; and manufacturing sector activity was at its highest in the past eight months. In the April-June quarter of FY23, GDP grew 13.5 per cent. Despite being lower than the RBI’s projection of 16.2 per cent and also lower than the 20.1 per cent of Q1FY22, a 13.5 per cent growth rate is not to be scoffed at. Plus, there are signs of sequential recovery, especially in contact-intensive services. And with inflation moderating, one is cautiously optimistic.

But despite these green shoots, India, one of the bright spots in the global economic morass, will have to execute a balanced walk through fire to attain and maintain the same kind of growth momentum.

CONFLICTING SIGNALS

There are opposing signals emanating from different quarters. For example, private final consumption expenditure—which is a measure of consumption of goods and services by individuals—grew by 25.9 per cent year-on-year (YoY) during April-June, while gross fixed capital formation, which is a proxy for investment activity, grew 20.15 per cent. Yet, Madan Sabnavis, Chief Economist of Bank of Baroda (BoB), feels private investment is picking up only in certain segments of the economy, and not happening on a broad scale. “The question is, fundamentally are we very strong? The answer is no. We still have weaknesses. We have weaknesses when it comes to inflation, consumption, private investment,” he says.

A report from BoB, using capex data from CMIE, a private research firm, shows that investments in new projects have fallen from Rs 5.9 lakh crore in Q4FY22 to Rs 3.7 lakh crore in Q1FY23. The decline was broad-based, with the biggest decline happening in manufacturing where new project announcements fell to Rs 1.4 lakh crore in Q1FY23 from Rs 2.3 lakh crore in Q4FY22. And while credit demand is picking up pace—with accretion in Q1FY23 at Rs 2.6 lakh crore compared to Rs 2.1 lakh crore seen in Q4FY22—it is driven by personal loans, and not credit accretion to industry. And while BoB’s credit offtake increased 14.5 per cent as of July 29, more than double the growth it saw a year ago, the report says some of it may have been fuelled by higher working capital requirements, which is a reflection of improved investment demand.

Former RBI governor D. Subbarao says India’s big challenges are in sustaining the growth rate and in lifting millions of people out of poverty. “The medium-term challenges are in improving education and health outcomes,” he says, adding that around the world, countries that have moved from low income to middle income over the past 50 years—in East Asia, China, Latin America—have all done so by investing in education and health. Subbarao also cautions that unemployment is the biggest challenge India faces today: “Twelve million people are joining the labour force every year. We are not even able to generate half as many jobs… the problem is reaching explosive proportions.”

The two measures of jobs and employment—labour force participation and unemployment rate—are both challenged. The labour force participation rate—people who are working or looking for work and therefore form the labour force—has dropped to 40 per cent of the 900 million Indians of legal age, from 46 per cent six years ago, according to CMIE. By comparison, the participation rate in the US was 62.2 per cent this June. And the unemployment rate, which is the percentage of people within the labour force who are not working, has been hovering around 7-8 per cent, up from about 5 per cent five years ago, per CMIE. “It’s very rare to find economies where the GDP is growing rapidly but employment is falling; only India is one such case. And it’s been true from 2011 onwards,” says Jayati Ghosh, Professor of Economics at University of Massachusetts, adding that if we cannot take advantage of the demographic dividend, it will become a time bomb.

But there’s a twist here, too. This August, according to CMIE, India’s unemployment rate increased to a one-year high of 8.3 per cent. However, the provisional payroll data of EPFO released on August 20, 2022 says that EPFO has added 1.84 million net members in June 2022, an increase of 9.21 per cent compared to May. “One million jobs addition is a very good sign…. But my major concern is the labour force participation rate, which is at 43-44 per cent in India, while the general average is 55 per cent, and in some countries it is up to 70 per cent,” says Rajiv Kumar, former vice chairman of NITI Aayog.

What these point to is a matter of jobless growth. “One fallout of the pandemic was that companies are trying to work with a smaller labour force. So, the demand for labour for jobs today has actually come down in the organised sector. Most of the jobs created during the pandemic have been a sneaky kind of thing. That’s not going to keep propelling the economy,” says Sabnavis.

THE EXPORTS ISSUE

Another alarm bell for the economy going forward is exports. “In FY22, half of India’s GDP growth actually came from exports. Very few people realise how important exports have become for India’s growth. Now that the global economy is slowing, we are already finding that export volumes have begun to fall, and that is worrying,” says Pranjul Bhandari, Chief Economist of HSBC India, adding that the exports growth story comprises two parts. One, high-skill exports such as mobile handsets, drugs and IT services have been doing very well. And two, low-skill exports such as textiles and agri exports have not been faring well, despite India having abundant labour. Currently, the challenge for India is to keep high-skill exports soaring, and pull up low-skill exports, she says.

In FY22, merchandise exports touched an all-time high of $420 billion. But imports grew further, to $610 billion in FY22, creating a trade deficit of $192 billion and contributing to a current account deficit (CAD) of 1.2 per cent of GDP. This year, with exports falling and imports rising, the CAD is expected to further increase, creating a potential challenge for the country’s forex reserves. So far this fiscal (April to August), merchandise exports have grown 17.1 per cent YoY to $192.59 billion, and imports have risen 45.64 per cent YoY to $317.81 billion. Experts peg the CAD to end at 3 per cent of GDP in FY23. Why are exports falling this year? The US and Europe, the primary markets for Indian exports, are facing recessionary and inflationary pressures. Demand for Indian merchandise, therefore, has shrunk.

In addition, the finance ministry, in its monthly economic report for June, expressed concern about the re-emergence of the twin deficit problem—CAD and fiscal deficit (which is excess of government expenditure over revenue receipts and external grants)—due to higher commodity prices and rising subsidies. However, economists say the fiscal deficit target of 6.4 per cent for FY23 is likely to be met, but a downturn in export growth will widen the trade deficit leading to an increase in CAD. “We really need to focus on CAD; 3 per cent of the GDP is a high limit. We really need to go below that point as some elements that have contributed to the increase in our [forex] reserves, are volatile in nature. And those elements are the ones which really pull down the exchange rate,” says noted economist and former RBI governor C. Rangarajan.

For example, the drying up of funding for start-ups has slowed the pace of FDI inflow into India. “The worry is, this kind of FDI money takes time to slow but also takes time to go up again. So, now that it has slowed, it may be a while before it picks up again,” cautions Bhandari of HSBC. According to a report from Tracxn, venture funding for the Indian start-up ecosystem plummeted by 33 per cent to $6.9 billion in the April-June quarter (Q2) from $10.3 billion in the first quarter (Q1) of this calendar year.

In the next 12 months, out of India’s total external debt of about $620 billion, about $267 billion is due for payment. This may have implications for the forex reserves. The RBI’s weekly statistical data shows the country’s reserves fell by $6.687 billion to $564.053 billion in the week ending August 19, marking its lowest level in over two years. The slump in forex reserves by a touch over $67 billion since the start of the Ukraine crisis and nearly $80 billion from its all-time highs last year echoes the slide in the rupee from about 74 per dollar to near 80, a level that analysts say the RBI has defended ferociously.

“Over the last six months, I believe RBI has sold about $50 billion in order to defend the exchange rate to man volatility. So, the market looks not just at the level of reserves, but how rapidly that is depleting… there is a market sense that the reserves are falling faster than expected,” says Subbarao. Even while saying India’s reserves are adequate currently, he questions how long RBI’s defence can hold out, considering that the REER (real effective exchange rate) is about Rs 104 to a dollar. This means that the “Rupee is slightly overvalued, which means that there is room for some depreciation. If RBI fails to lean against the wind and prevent depreciation at any cost, it might be a costly defence… So, RBI’s policies should not target exchange rate, but only manage volatility. You should allow the exchange rate to depreciate consistently with the fundamentals and man only the trajectory of depreciation.”

Bhandari of HSBC agrees with this approach: “If there is pressure for the rupee to weaken, we should let it weaken. We should not worry if the rupee crosses 80 and goes to 81 or 82 because a competitive rupee protects your exports, and corrects the CAD over time.”

INFLATION & DEFICIT

Last year, India’s fiscal deficit was at 6.7 per cent. This year, the target is to keep the fiscal deficit at 6.4 per cent, but economists are doubtful. “The budget estimate was 6.4 per cent. Since then, a lot of problems have emerged—we’ve had to expand our food distribution, fertiliser subsidy bill is up, we’ve had to cut export taxes, RBI’s dividend has been a bit lower, some of the privatisation plans are not really working out yet... So, I think we will miss our fiscal deficit target,” says Bhandari, but she also feels it won’t be a big problem. “I think we will end the year at something like 6.7-6.8 per cent, for the simple reason that fiscal deficit is always a per cent of GDP. And the GDP today will be much higher than what we had envisaged at the time of making the budget—nominal GDP growth is high because of inflation. So, that is helping us.” She further adds that the windfall tax on ATF, petrol and diesel will prevent fiscal slippage.

The other challenge is retail inflation, despite it moderating to 6.71 per cent in July from 7.01 per cent in June. “Inflation is happening more on account of the supply side. And what we are trying to do is reduce inflation with demand side [interventions] by increasing interest rates, which has to be done, but it takes time to work,” says Sabnavis of BoB. The other problem, as economist Kumar points out, is that an erratic monsoon will put pressure on food prices. “Because of climate change, we have monsoon with overall distribution that has been quite erratic in some of the major rice-growing states. So, that might also put some pressure on food prices,” he says.

Adds former finance secretary R.V. Gopalan: “Headline inflation is coming down, but the core CPI inflation is high. Food inflation is another worrying area. That is a little seasonal, but I’m having some worries about the cereal side with the acreage for paddy going down compared to last year.” According to BoB’s report, the area sown in FY23 for cereals has gone down from 54.2 million to 51.6 million hectare; area sown for rice from 37.5 million to 34.4 million hectare; and the total area sown has also fallen from 103.9 million hectare to 101.3 million hectare.

Economy watchers say the recent moderation in inflation is mainly driven by the base effect, which is likely to turn unfavourable. The RBI noted some moderation in CPI, but retained its FY23 inflation forecast at 6.7 per cent YoY. A DMI Finance report says: “An analysis of 299 items of the CPI basket revealed that the share of items with inflation above 6 per cent increased from 46 per cent in June 2022 to 50 per cent in July 2022, reflecting the broadening of the inflationary pressures.” One economist, who wishes to remain anonymous, says that headline CPI is likely to be elevated in the coming months with the waning of the base effect, increased risk of imported inflation with the depreciation of the currency, elevated input cost pressures, and catching up of services inflation.

A unique situation really, of some economic parameters improving and others worsening. There are several undertones and nuances to both sides, and what is certain is that it will take deft handling of the economy by the RBI and the government to keep the fledgling green shoots from drying.

@RajatMishra9518