Figures not adding up
India’s GDP will grow at just 5% this year. That’s the Modi government’s own estimate. Even this dismal figure could well be an overstatement. The country’s income grew by just 4.8% in the first six months, and it will have to grow at 5.2% in the second half for the CSO’s GDP estimates to come true. Most pundits find that hard to believe.
What is even more alarming, is that nominal GDP growth — or GDP in current prices — is going to be just 7.5%. That’s the lowest nominal GDP growth in 44 years. Some would argue that nominal growth doesn’t matter, because what counts is the real growth in output of goods and services. But that does not take into account the psychological impact of low growth in money income.
To understand that, let’s take the example of Mr Sharma from Ludhiana. He is disappointed with his raise this year. Over the past five years, his increment has hovered around 3-5%. Before that, he used to regularly get double-digit pay hikes. His friend, Mr Gupta, who teaches economics in a local business school, explains that even though he used to get 10% plus raises five years ago, his real income growth was lower, because retail inflation was higher than his increment. On the other hand, his 3-5% salary hikes over the past five years, have given him a higher real income growth, because retail price rise is so low.
But Mr Gupta’s ‘rational expectations’ of his friend are irrational. People ‘feel good’ about big jumps in money income, even when they face high inflation. It encourages them to spend more and invest more, because of an imagined ‘wealth effect’. The exact opposite happens when money income doesn’t grow. Even if the prices of things they buy stay flat, a low growth in nominal income, creates a ‘poverty effect’, stopping people from spending.
This is even more true for businesses. Corporates mostly care about their money income, as do people who invest in their shares. An auto company, for instance, could end up selling fewer cars, but make higher profits by selling them at higher prices. Real output doesn’t matter to them, at least in the short run, as long as money income is increasing.
Similarly, if sales volumes go up, but a company loses pricing power, its money income will not grow. This will make shareholders dump the stock and force the company into contraction mode. Other entrepreneurs, who were thinking of entering the sector, would hold back on investments. So, fewer jobs would be added and fewer machines would be sold.
This is what makes the 7.5% nominal GDP growth so dangerous. It is going to discourage consumers from buying more and stop corporates from investing more. What is more, it will also affect the government’s ability to spend. This is because, fiscal deficit targets are based on nominal GDP. The Modi government assumed a 12% nominal GDP growth in 2019-20, and therefore, estimated its Rs 7 lakh crore fiscal deficit will end up being about 3.3% of GDP. The new nominal GDP growth projection of 7.5% will immediately raise fiscal deficit to 3.45%, without a single additional rupee being spent.
The government understands that, and has asked all ministries to curtail their budgeted spending. Ministries were earlier allowed to spend 33% of their budget in the last quarter. A new directive has cut that to 25%. This will make it even more difficult for the economy to revive in the second half.
That is because government spending has been the single-biggest driver of GDP growth in the first half of this fiscal. Government Final Consumption Expenditure grew by 12.3% in real terms and 15.6% in nominal terms. It was the only segment of the GDP that showed double-digit growth in both constant and current prices. If government expenditure is removed, GDP growth in the first six months of this fiscal was just 3.8% in real terms and 4.8% in nominal terms.
The government has a big problem on its hands. Even if it meets all its spending and revenue targets, the low nominal GDP growth will make this year’s fiscal deficit look bigger. All reports suggest that the government is having a hard time meeting its revenue target. GST collections have been sub-par in almost every month, and disinvestment targets look very difficult to achieve.
The only way out is to say goodbye to the FRBM Act, which restricts government spending. The government has to take a radical step and forget its fiscal deficit target. It has to spend another 2-3% of GDP to revive the economy. This was done by the UPA government, right after the global slowdown, and it paid dividends in terms of growth and employment.
The Modi regime needs to use this massive slowdown to restructure policies that every government has been following since Narasimha Rao liberalised the economy in 1991. Three decades of reforms have turned India into an economy that caters to the top 10% of the population that buys cars, durables and consumes the bulk of all fast-moving consumer goods. India needs a hard reset to reorient its investment priorities.
In a situation, where there’s no demand, the private sector is not going to invest. It is only the government which can spend — to create jobs, spur consumption and direct investments — without an immediate profit motive. This requires the government to re-enter the economy, and direct what to produce, how much to produce and for whom to produce.
This does not, necessarily, have to be through the public sector. Government infrastructure projects are often executed by private companies, who are given exact targets and guaranteed some returns on capital. If it is done to build roads and bridges, there’s no reason why it cannot be done to make sugar, saris or shoes.
But that will mean taking on the fiscal hawks backed by global finance. The question is whether the Modi regime has the political will to do it.
The author is a senior economic analyst
