Many years ago, before Covid struck India, the Indian economy faced severe headwinds. It looked like a repeat of 2011-12, but with greater intensity. Growth fell continuously for eight quarters—except for a 0.08-percentage-point blip between December 2018 and March 2019. What was roaring at 8.2 percent in March 2018 had fallen to 3.1 percent in March 2020. It appeared to be a free fall.
The government responded with supply-side measures. There was a steep reduction in corporate tax rates at a cost of Rs 1.5 lakh crore to the revenues of the state. The expectation was probably that more profit would automatically lead to more investment by the corporate sector and, consequently, more employment, higher incomes and greater consumption. The hope was for a beneficial cycle to strengthen the economy and create sustained growth.
But before the impact of these measures was felt, the pandemic hit. The supply-oriented stimulus measures had little effect; the RBI rescued the economy through some significant monetary policy measures.
Following the pandemic, there was a sudden burst of energy in the economy as consumers gave free expression to suppressed demand. The monetary policy continued to be easy, and as a result production could keep pace with the increasing demand. The second quarter of 2024-25 has, however, been depressing.
Manufacturing growth stood at just 2.2 percent, while export growth barely reached 2.8 percent. Last year, manufacturing was driving the economy. The GDP growth rate fell to 5.4 percent, the lowest in seven quarters and well below the 8.1 percent recorded a year ago. The first-half GDP growth rate is at 6.05 percent, below the RBI's optimistic projection of 7.2 percent for the year. Now, the expectation is that the economy will grow at 6-6.8 percent.
The macroeconomic figures, while they are not yet alarming, do point to a few specific danger signals. Growth of private final consumption expenditure is down to 6 percent in the second quarter of this financial year. The corresponding figure for government final consumption expenditure is 4.4 percent, up from minus 0.2 percent in the first quarter but considerably lower than the previous two years.
Growth of gross fixed capital formation , which had touched double figures in 2021-22 and 2022-23, was 7.5 percent in the first quarter of this financial year and 5.4 percent in the second. Consumer price inflation remains high at over 6 percent in October, leaving little room for RBI action on the monetary front. The most disquieting figure is in foreign trade, where growth rates were 2.8 percent in exports and (-)2.9 percent in imports.
India's economic policy hitherto has primarily been corporate-oriented. In late 2019, corporate tax rates were cut by 10 percent, with the government incurring a revenue loss of about Rs 1.5 lakh crore, as stated by the Finance Minister. The insolvency code has primarily benefited the big and the rich, and banks have had to take enormous haircuts.
In January 2023, this newspaper said in an editorial: "Before the IBC came into force, average recoveries were 26 percent, and the time taken for resolution was four years. The banking and insolvency regulators, which once hailed the IBC as the biggest reform (bigger than GST) of our times, are now finding it difficult to explain the massive haircuts banks are taking to resolve cases through the IBC. With an average recovery rate of 30 percent, banks lose 70 percent of the debt given to these companies. This is not the pretty picture one had expected when IBC was implemented."
There has been considerable outward investment also. In the words of India Brand Equity Foundation, "In 2024-25 (April-September 2024), overseas direct investment stood at $8.9 billion. Of the total amount invested, $12.1 billion was in the form of issuance of a guarantee, $3.1 billion as a loan, and $5.8 billion infused in the form of equity. Additionally, Singapore was the top investment destination with $2.8 billion. This was followed by the US accounting for $1.1 billion, and the Netherlands, with $809 million in investments. As of FY23, India has maintained its spot as the second-largest source of foreign direct investment projects for the UK. Indian businesses have invested in 118 projects in the UK and generated around 8,384 jobs, according to the High Commission of India in London."
India needs to rethink its economic policy and balance supply-oriented measures with demand-oriented ones, particularly since the global economic outlook is described as “underwhelming” by the IMF and, therefore, foreign trade may be sluggish. This would involve putting in place a set of measures that would stimulate demand.
The chief economic adviser recently pointed out that corporate profits must be shared with employees to generate demand. Speaking on December 5, he warned against “creeping informalisation” of the workforce. He called low wages and contractual hiring in the corporate sector "self-destructive" as it depresses demand for the goods and services they produce.
Both informalisation and low-wage growth and contractual hirings have happened while corporate profit has grown about four times in four years, with the profit-to-GDP hitting a 15-year high. The finance minister also expressed similar views when she said that the purchasing capacity of Indians is improving, but within India, you also have concerns of wages saturating. We are quite seized of these factors which might have a play on India's own consumption.
I am reminded of a research first published as a working paper in 2020 by David Hope and Julian Limberg of London School of Economics's International Inequalities Institute and King's College London. They analysed the economic effects of significant tax cuts for the rich across five decades in 18 wealthy OECD countries. They concluded that the rich got more prosperous, and there was no meaningful effect on unemployment or economic growth.
Hopefully, government decision-makers will look seriously at fiscal measures to introduce more balance in the economy, mainly because high inflation presently seems to preclude effective action on the monetary side.
(Views are personal)
K M Chandrasekhar
Former Cabinet Secretary and author of 'As Good as My Word: A Memoir'
(kmchandrasekhar@gmail.com)