The recent full-year GDP release, the conclusion of voting and the imminence of the next administration make this an opportune moment to take stock of the economy. But with GDP growth surging past 8 per cent, is there much to contemplate?
First, a caveat. The computation of GDP benefitted from significantly lower subsidies last year, which is unlikely to repeat. Therefore, Gross Value Added (GVA) appears more representative of underlying dynamics and that has slowed from 8.3 per cent to 6.3 per cent over the last four quarters. For the full year, however, GVA still averaged 7.2 per cent, which is very creditworthy, and reflects the confluence of four growth drivers: A large infrastructure push by the Centre complemented by the states last year; a residential housing market that, admittedly powered by the top-end, is flourishing; healthy financial sector balance sheets that are driving credit deepening, and a surge in service exports underwritten by Global Capability Centres that have helped white-collar job creation and consumption.
But we cannot take future growth for granted. Why? Because sustained growth depends crucially on investment prospects. It’s investment that creates jobs, which creates demand that, in turn, validates the initial investment and attracts more, thereby perpetuating a virtuous cycle. Thus far, much of the investment has been driven by the public sector. Fixed investment has risen from 31.6 per cent of GDP pre-pandemic to 33.5 per cent but more than half of this is public investment, which will eventually face fiscal constraints.
Why? Because even as the Centre sharply consolidated its fiscal deficit last year, state deficits widened, such that the combined deficit is still close to 9 per cent of GDP. Even if the combined deficit is reduced to 7.5 per cent of GDP, as currently envisaged, nominal GDP growth will need to average 10 per cent — more than achieved last year — just to stabilise public debt, let alone bring it down. The implication: Even more fiscal consolidation may be required for debt sustainability.
This will make it harder for public investment to do the heavy lifting, year after year. The baton will have to pass to the private sector. Real estate investment has picked up smartly, but what’s delaying the corporate capex cycle? Quite simply, demand visibility. Balance sheets are strong — corporates have deleveraged and profits are healthy. But investment is endogenous — it requires demand visibility for corporates to commit. Where is the lack of demand showing up? In capacity utilisation rates that have been unable to break out of the 74-75 per cent range, in nominal sales growth that has been in single digits, and in soft core inflation, suggesting corporates lack pricing power. Add to this, the quantum of excess capacity that China is exporting globally, and you can see why corporates are diffident to invest.
A demand deficiency is typically met by countercyclical fiscal and monetary policy. But fiscal policy is constrained for the reasons described above. And while monetary may have some space to ease, it’s likely to be limited by the high-for-long stance of the US Fed. More fundamentally, if demand is constrained by more structural factors — as discussed below — any cyclical response will have limited efficacy.
Therein lies the policy challenge for the next administration — to boost demand without the luxury of fiscal space. So where can that demand come from? With government spending needing to eventually retreat it will need to come from private consumption and exports.
On its part, consumption has disappointed, growing at just 4.2 per cent over the last five years, constrained by its own duality. Upper-end consumption has been strong, but lower-end consumption — though healing in recent months — has lagged, reflecting a dichotomous labour market. But slowing consumption predated the pandemic. As the Household Consumer Expenditure Survey revealed, real per-capita consumption growth had downshifted over the last decade. A consumption revival is therefore key to investment prospects.
This will need to be complemented by exports. No country without a large commodity endowment has experienced sustained growth without exports firing. Even as services exports have surged, the share of manufacturing exports to GDP has declined discernibly. For exports to move the investment needle they will need to broaden.
Against this backdrop, what should the next administration focus on?
First, an overarching strategy to boost employment. Tepid consumption growth has its genesis in the labour market. India’s employment to the working age population has been under pressure for at least two decades, suggesting employment has not kept pace with the demographic transition. To be sure, the ratio has improved in recent years. But the quality of jobs remains a concern, with more than half the jobs created in the last five years, for example, in agriculture.
A more holistic way to measure the ask is to look at labour’s contribution to GDP growth, versus that of capital and total factor productivity (efficiency). What one finds is that over the last two decades, labour’s contribution (including human capital) is much lower than growth of the working-age population would suggest, in sharp contrast to what China and Korea achieved during their demographic transitions.
This underperformance, in turn, can be explained by Indian manufacturing becoming progressively more capital-intensive. Strikingly, in a labour-abundant country, entrepreneurs are choosing capital-intensive techniques and sectors. Their revealed preference suggests that, once adjusted for productivity and friction, labour is a relatively unattractive factor of production.
And therein lies the policy challenge — to make labour a more attractive factor of production. This will require a full-court press on both the demand and supply sides. From stepping up education, health and skilling, to rationalising labour laws, incentivising labour-intensive manufacturing and enabling small firms to grow, it will span the full ambit of policymaking.
Second, India will need to develop an “export ecosystem”. This will entail doubling down on education and skilling to maintain India’s comparative advantage in service exports. It will also mean harnessing the potential of labour-intensive manufacturing exports — where China is ceding significant space. The to-dos are well known — reducing import tariffs, investing in coastal economic zones where factor markets (land, labour, power) and infrastructure are not a binding constraint, engaging in trade facilitation and managing the exchange rate judiciously.
But all this will require large public investments in human and physical capital. Where will that fiscal space come from if deficits need to be reduced? It will have to come from higher tax revenues and asset sales. The good news is that India’s combined tax/GDP is expected to surpass 18 per cent of GDP for the first time in 2023-24. But more is needed. The necessary fiscal consolidation needs to occur from revenue augmentation, not expenditure compression.
In the coming weeks, a slew of policy advice will emerge for the next administration. But political capital and state capacity should not be dispersed over laundry lists of nice-to-haves. Instead, the focus should be squarely on identifying the binding constraints to growth and releasing them. The last decade has been spent repairing the supply side — from the banking system, to infrastructure, to housing and bankruptcy. Now the focus must turn to structurally
boosting demand through employment, consumption and exports.
The writer is Chief India Economist at J P Morgan. All views are personal
