The early gross domestic product estimate (GDP) released in January this year by the national statistical agency assessed India’s growth at 5 per cent this financial year. It is the slowest pace of growth in the last 11 years, the third successive year of deceleration, and the fall in real GDP growth this year is a hefty 1.8 percentage points over last year (6.8 per cent). Still, the official advance GDP numbers were not a surprise because all forecasters had downgraded much before, as did the central bank last December. In fact, many private analysts expect the growth out-turn to be even lower, below 5 per cent, as consumer spending failed to revive as anticipated in the October-December festival quarter and the steep decline in tax revenues has forced the government to restrict spending to one-fourth of the annual budgeted amounts for various ministries. The real worry is about what lies ahead.
Hard times seem inevitable. As the budget day approaches, all expect the government to respond appropriately to the stretching economic weakness. But rather than taxation and spending changes to stoke demand, it is the reverse or subduing effects of the withdrawal of chunks of expenditure that will play out. A retreat or slower pace of government spending exerts itself through reduced purchases, orders, and contracts whose impact radiates across other segments of the economy. The extent of such drag can be seen by the enormous spending support to growth by the government in recent times: about 45 per cent of the July-September quarter’s 4.5 per cent GDP growth came from such spending that grew an exceptional 16 per cent year-on-year and double its pace in the first quarter of April-June; minus this booster, GDP growth was below 3 per cent. Similarly, government expenditure raced phenomenally at 15 per cent and 9 per cent in the last two years (2017-18 and 2018-19); for 2019-20, estimated growth is a further 10.5 per cent.
Lower this pace and aggregate GDP will feel the pinch. The troubling thought is not only for the remainder of this year, when pressures to make ends meet typically intensify at the end. Government spending is likely to be forced to slow down next year too. This is because of the widening gap in public revenues and expenditures. Spending has expanded significantly in the past two years, especially its current or revenue component; this consists mainly of salaries, interest payments, subsidies and other transfers (for example, schemes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme, the Pradhan Mantri Kisan Samman Nidhi). At the same time however, tax revenues have trended in the reverse direction, that is, slowed down. This tightens financing of expenditures, the committed component of which is impossible to cut. Tax revenues fell short by Rs 1.65 trillion last year and the deficit is likely to be larger this year — Rs 2.6-3 trillion is the commonly cited range as both direct and goods and services tax collections are hit by the rapid slowing of output. Non-tax sources, that is, divestment and asset sales, have not matched expectations so far. There are frequent reports of frantic dividend revenue-seeking by the government, namely, from oil companies and the Reserve Bank of India; plans of yet another immunity scheme allowing direct taxpayers to declare any additional incomes in the past five-six years without penalty or prosecution, and the recovering of past dues from telecommunication firms for adjusted gross revenue payments, which may be partly paid. The extent of the public revenue shortfall is unlikely to evaporate very fast. At the least, an upswing in activity is essential for higher growth in revenues. But the portents for this are uncertain and underwhelming at this point.
So even as all look towards demand support in the upcoming budget, the government does not have the wherewithal for pleasing booster shots. Over-optimistic revenue projections would erode credibility, as happened last July. Raising taxes in one segment to finance a stimulus for another part will be counter-intuitive in a slowing economic context. Moreover, fresh taxation could invite backlash, further depress sentiment in a replay of last year’s budget. Under these resource-scarce circumstances, public expenditure would have to slow down, which would be a weakening force.
Rising inflation is the next spoiler. The RBI eased policy rates by 135 basis points last year, devoting equal policy attention to ensure that the borrowers benefit from its pass-through via banks and are encouraged to spend more. But the inflationary expectations of households have adjusted quickly to food prices that are rising since mid-2019. Retail food inflation galloped from 3 per cent last August to 14 per cent in December, pushing up overall retail inflation, on which monetary policy is based, to 7.4 per cent. These developments, along with some other factors such as hikes in telecom tariffs, fuels and liquefied petroleum gas, possible fiscal expansion in the forthcoming budget, have injected caution in the otherwise softer interest rate environment. The RBI rested its easing cycle last month, turned more watchful. The bond market has reacted with higher inflation risk premium, keeping the 10-year yield — benchmark for banks’ loan rates elevated.
Many assure the food price rise is temporary; it will pass over, leaving the easier monetary situation unchanged. But matters may not be all that sanguine. If inflationary beliefs of the public get entrenched owing to the persistence of food inflation for several quarters, that
increases the risk of feeding into wages (for example, public servants’ salaries are indexed to retail inflation) and thereon to other prices. This could make things more difficult than at present: high inflation reduces real incomes or purchasing power; instead of additional spending encouraged by lower interest rates, consumers and producers are pulled down by lower disposable incomes and costlier input.
Finally, new or unanticipated risks and shocks surfaced in the past few months from civil disturbances and protests that in turn, elicited disruptive internet shutdowns and prohibitory orders by various state administrations in many parts of India. These hurt consumption and business: for example, several companies explained that their previous quarter sales suffered from store closures, lower footfalls in showrooms and disrupted supplies, last month. Food orders, restaurant visits, e-commerce were affected likewise, according to news reports. Growth in the travel and tourism industry also reduced because of cancellations and cautionary advisories from foreign governments. Output losses caused by internet shutdowns in 2019 (estimated above 100, for about 4,196 hours by Top10VPN, an internet research firm) are calculated about $1.3 billion for 2019, according to The Global Cost of Internet Shutdowns report released earlier this month; this figure is an underestimate, says the report, as the focus was region-wide shutdowns, which tends to exclude many incidents. Further repeats of such shocks cannot be ruled out ahead. It is notable that the influential global risk-assessment consultancy, Eurasia Group, has reportedly placed India as one of 2020’s top geo-political risks.
When growth falls as steeply as it has this year, and the slowing is extended to the medium-term, emerging out of it takes longer and is more difficult because households and firms are more enduringly weakened than in a short-lived, cyclical downswing. And if policymakers lack resources or policy levers to arrest the sliding, a painless recovery is harder to achieve. The current economic situation is precisely at such a confluence — the government can do little by way of fiscal responses, an easing monetary cycle expected to manage the downswing faces uncertain inflationary challenges. Unless fortune unexpectedly smiles, hard times seem inevitable ahead.