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Believe It or Not, We’re Hot

India’s surprisingly high growth for 2023-24 has caught analysts off guard. Compared to the average forecast of around 6% at the start of the fiscal year, growth is likely to print at 8%.

India’s surprisingly high growth for 2023-24 has caught analysts off guard. Compared to the average forecast of around 6% at the start of the fiscal year, growth is likely to print at 8%. Without unforeseen shocks, 2024-25 GDP growth is expected to remain in a respectable 6.5-7% range, given that it comes on a high base.

Some eyebrows have been raised about the credibility of the numbers, and others about technical niggles. One is the effect of an exceptionally low GDP deflator — the index that is used to filter price effects and arrive at a measure of ‘real’ growth — that has jacked up the growth rate. However, the fact is that all granular indicators of activity point to strong growth momentum. It is perhaps sensible to recognize this unexpected traction in the economy, rather than get bogged down in technical quibbles.


What is happening to the economy, and why has it beaten expectations by a mile?

To begin with, it is sensible to see growth in conjunction with inflation data, especially inflation that has been shorn of volatile components, such as food and fuel. This adjusted, or core, inflation has been dropping steadily over H2 2023-24, down to 3.3% in February, suggesting that even with such high growth rates, the economy has not ‘overheated’.

If one goes by economic theory, this could happen if there are gains in productivity. This seems like a plausible argument, given the sustained improvements in physical and social infrastructure over the last few years. This would also suggest that India’s potential growth for the medium term has risen.


What could this suggest to policymakers? Economic theory suggests that higher productivity should produce a higher neutral interest rate, the rate at which central bankers hit the jackpot — with inflation remaining stable at a desired rate while keeping growth at a comfortable clip.

However, enhanced potential growth also means that RBI can breathe a little easier at much higher levels of growth than in the past, and not fret over excess growth straining markets and rekindling inflation. The upshot is that in deciding when and how much to cut rates, RBI needs to get a handle on the likely productivity gains and changes in potential output and growth. As of now, there seems little reason to expect rate cuts. Cuts, when they do happen, could be shallower than in the past.

The composition of growth also needs to be looked at more closely. Investments, particularly infrastructure-building led by GoI, have led the charge, while consumption growth has significantly lagged. Average GDP growth has been close to 7.4% in in 2022-23 and 2023-24, while consumption growth has averaged only 4.9%. In previous high-growth phases such as 2005-08, a popular reference period, consumer spending grew at a much healthier pace, 6.2% on average in this period, with headline growth averaging 7.9%.


This is somewhat puzzling given the massive push for infra, especially roads. Construction is highly labour-intensive. Thus, infra projects lead to large hirings of workers, money in their hands and spending on consumer goods. The fact that this relationship has weakened could mean that construction has become more equipment-intensive, and job push from construction has waned.


A calculation by HDFC Bank, based on RBI’s KLEMS data and GDP statistics, shows that the labour input per construction unit has fallen from 2015 to 2019 (when the data series ends). Thus, to ensure that growth generates jobs, we need to supplement construction with other employment engines.


That said, sluggish consumption growth is not surprising. The debate on whether the economy is exhibiting a K-shaped recovery, with the rich getting richer and the poor getting poorer, is a trifle misplaced. What might be happening is a dual-speed recovery, with the poorer households and small firms recovering slowly from the effects of the pandemic than those closer to the top of the income and size pyramid.

It does not take rocket science to understand why the proportional damage to poorer households’ and smaller firms’ balance sheets would be greater with a non-discriminatory shock like a pandemic. Prudent programmes like free food might have prevented acute distress. But all ‘discretionary’ spending for the less affluent has suffered from the Covid shock that has lingered.Hence, mass-market consumption would take longer to perk up than premium products. Rural spending, which has a proportionally larger share of the mass market, is now showing signs of recovery, which should pull consumption growth closer to the historical trend.

The economy’s report card looks good. The challenge is ensuring it gets straight ‘A’s over the long term. One way to ensure that is to analyse the ‘structural’ changes that have happened along the way and recast policies appropriately.

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