Commuters driving on Mumbai roads experience potholes via the rattle and shake of their bones. The Indian economy’s unevenness is a similarly bumpy ride endured, despite multiple assertions that the worst is over and a glorious future lies ahead. There are a lot of hopes riding—pun unintended—on the budget but the journey promises to get bumpier. So, better strap up.
The Indian economy is entering a crucial stretch and how it behaves in the coming months will depend on the government’s annual budget exercise that’s just around the bend.
The political economy, as usual, will have an outsized influence on the budget. India is mid-way between two general elections—the last one was in 2019.
The BJP’s budget route to poll success
In the next few weeks, crucial polls are due in Uttar Pradesh (UP), Punjab, Goa, Uttarakhand, and Manipur, with about 690 seats in the balance. Next year, it will be the turn of Gujarat, Karnataka, Meghalaya, Mizoram, Nagaland, Himachal Pradesh, and Tripura to vote, with an almost equal number of seats in contention. And then 2024 is the big gig.
India’s ruling Bharatiya Janata Party (BJP) needs to win as many state elections as possible; its reputation hinges on victories in UP and Punjab. The BJP’s poor run over the past two years, especially the humiliation in West Bengal and Tamil Nadu, has left a visible dent in its image as an infallible election-winner.
Unarguably, the budget (to be announced on Feb. 1) will be finance minister Nirmala Sitharaman’s opportunity to play Santa, handing out giveaways and free passes to crucial voter blocs.
It might then make sense to assess the state of the economy and figure out where the budget could be headed. Spoiler alert: lots of bumps ahead.
The state of the Indian economy
The first stop is the statistical ministry’s advance estimate of the full year’s (India’s fiscal year runs April to March) gross domestic product or GDP. Multiple skeins are intertwined here.
India’s real GDP (adjusted for inflation) for 2021-22 is likely to grow by 9.2% over the previous year. Various components from the demand side of the equation—private consumption, government consumption, or capital expenditure—have shown the first signs of a hesitant recovery. But keep that party on hold.
Remember this is only an “advance estimate,” or a guesstimate about the March 2022 picture based on economic activity till November-December; it will be updated once again by end of January. The real picture will emerge only on May 31.
There are other reasons to hold off premature celebrations.
First, the advance estimate was drawn up before Omicron proved its contagion credentials between the end of December and early January. The high rate of infection will have a dampening effect on the nascent economic recovery and may even shave off a few points from the final numbers. The IMF has cut India’s growth forecast to 9% for this fiscal from the earlier 9.5%, citing the impact of the omicron variant.
The industrial production numbers for November, released a few days after the GDP advance estimates, were already reflecting the first signs of an imminent slowdown.
Second, while 9.2% growth does look good, it is on the back of what the economists call “base effect,” or a 7.3% contraction during 2020-21 when the coronavirus impact was first felt most severely in the form of lockdowns and an abrupt halt to all economic activity. If we disregard 2020-21, since it was an unusual year, then the 2021-22 GDP estimate demonstrates the growth of only 1.26% over 2019-20.
Let’s stretch the argument further, contending that the world economy had already begun slowing down from January 2020 on early reports of coronavirus transmission, thereby affecting the last quarter (January-March 2020) of the 2019-20 GDP data. In that case, the advance estimates for 2021-22 represent growth of only 4.8% over 2018-19.
Here’s the rub. The first seven years of the Modi government—2013-14 to 2020-21—have delivered average GDP growth of only 4.9%. In short, the Indian economy has been in a structural funk for a while and the pandemic has made matters worse.
Remember, two imperious missteps underpin this stagnation: demonetisation in 2016 and the hasty but flawed introduction of a goods and services tax regime soon thereafter.
The other worry is current inflationary trends. The assault from prices will be two-pronged, almost pincer-like.
On one side, consumer inflation has been inching up for the past few months, fired by high food and fuel prices, and touched 5.9% in December. This is dangerously close to the Reserve Bank of India’s 6% tolerance level. On the other side is the more perilous wholesale price index, or WPI, which affects manufacturers. WPI grew by 13.56% in December 2021, after 14.23% in November; worryingly, it’s been in double-digits for some time now.
The danger is that producers are unlikely to fully absorb the price rise in inputs and raw materials; they will be looking to partially pass it on to end-users over the next few months, implying sustained future pressure on consumer inflation.
Slowing growth and high prices are a lethal combo. Add another explosive ingredient to the mix: unemployment.
Data for December 2021 from the Centre for Monitoring the Indian Economy show the unemployment rate at close to 8%. Now consider reports from Oxfam International and People’s Research on India’s Consumer Economy which show that the pandemic exacerbated inequality in India. This is a serious, combustible socio-political development.
Nirmala Sitharaman’s budget tasks
The burden of expectations is on Sitharaman to deliver the right notes. These hopes are also informed by the BJP’s self-goal on farm reform which provoked a prolonged agitation by farmers across Punjab, Haryana, and western UP. In November, the protestors’ unrelenting resilience and the approaching state elections forced prime minister Narendra Modi to repeal three contentious agri-reform Acts which were at the center of farmers’ ire.
It is, therefore, somewhat of a foregone conclusion that the budget will reach out to the rural populace, especially farmers, with incentives and handouts.
The pandemic had forced the government, in March 2020, to transfer cash directly to farmers, and also provide free food grain, and cooking gas. The supply of free grains, initially operated April-November 2020, had to be restarted in May 2021 after the second wave sent shockwaves through the economy.
Earlier this month, ahead of the five states going to the polls, prime minister Narendra Modi released a fresh tranche of 20,000 crore rupees ($2.65 billion) under the cash transfer scheme, expected to benefit close to 100 million agricultural households. The last payment was in August 2021.
Expect the finance minister to press harder on this accelerator.
Predictable cash flows have a salutary impact in an economy where uncertainty is the default mode, especially for an agricultural economy overly dependent on a fickle monsoon. Myriad other concessions (such as farm loans at low-interest rates or easier access to farm inputs) are expected to dot the budget document.
Sitharaman’s second focus area will be addressing growth stagnation which is leading to unemployment. Indications of her likely moves are already visible in the 2021-22 advance estimates.
The one bright spot in the thicket of data is head called gross fixed capital formation which is estimated to grow 28.5% during the year, providing some growth impetus to a reluctant economy. It stands for capital investment—that is, investment in roads, bridges or factories—made by both the government and the private sector.
It is, therefore, likely that Sitharaman will push for additional investments in building long-term physical assets. Investments in roads, bridges, or factories foster demand for cement, steel, and other inputs down the chain and create a virtuous cycle of economic renewal.
The high growth phase of the Indian economy during 2004-08 was largely driven by high investment rates, which have since dropped, particularly post 2016. Money spent on capital expenditure has a positive multiplier effect.
But capital expenditure by states is also proven to have a higher multiplier than that by the Centre.
Yet, ironically, the pandemic has left states struggling to husband resources. The centre, which should be transferring part of its tax revenues or borrowing and passing it on to states, given the dire emergency, has been parsimonious in sharing resources.
There will, expectedly, be questions about the impact of hand-outs on fiscal deficit. Traditionally the BJP, like other conservative parties, has been in the thrall of fiscal hawks who want lower welfare spending and low taxes rates for the rich. It is doubtful if Sitharaman will have the luxury of defending that ideology this time.
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