At the Root of Slowdown: It's Politics, Stupid

The villain of the slowdown is poor governance. Government expenditure is lower. Private sector capex is slower even as companies pile up over Rs 5 lakh crore. Consumption is poorer as consumers are haunted by the cost of living and employment uncertainty. The net result: rate of growth is lower than the rate of inflation. Inflationary politics has deflated growth. Sadly the electoral algebra favours taxpayer paid sops over policies for employment and growth.

Shankkar Aiyar | The Third Eye | The New Indian Express | 01 Dec 2024d

The murmurs and fears echoing in living rooms, bazaars and C-suites for weeks and months have come home to roost. All is clearly not well with the economy.

On Friday, the ministry of statistics informed India that GDP growth in the July-September quarter, at 5.4 percent, has fallen from 8.1 percent in the same period last year — the slowest in nearly two years. Gross value addition (GVA), at 5.6 percent, is lower than nominal GVA of 8.1 percent.

Yes, it is still the fastest growing large economy, but the economy is growing well below its potential. Given India’s demography, this entails risks in the medium and long terms, and carries political implications.

The reality of a slowdown is manifest in high-frequency data on consumer demand visible across sectors and corporate earnings which, by one estimate, have hit a four-year low. Indeed, a study by Motilal Oswal suggests Nifty earnings may be dismal and grow by a modest 5 percent this year. Worsening the picture is a steady erosion in urban wages impacting consumption.

Data points, though, didn’t shake or stir the nation’s money manager. The Reserve Bank of India on October 9 recorded that growth was slower in the first quarter, but asserted that GDP growth in the second quarter would touch 7.2 percent. This column — in a copy titled ‘Scent of a Slowdown’ — had observed that the forecast would be challenged.

As per the RBI, real GDP growth for 2024–25 was projected at 7.2 percent. At the halfway mark, GDP growth stands at 6 percent and the strike rate required to achieve the forecast is challenging, to say the least.

The granular details of the slowdown are stark. Manufacturing fell from 14.3 percent in the second quarter of 2023–24 to 2.2 percent; mining, which clocked 11.1 percent last year, has slid into contraction territory. Agriculture, at 3.5 percent, is growing faster than manufacturing.

The India story in recent years has been fuelled by public investment. On a year-on-year basis, the government’s final consumption expenditure has dipped from 14 percent to 4.4 percent in the second quarter this year; the gross fixed capital formation, which is code for new investments, has slid from 11.6 percent to 5.4 percent.

Effectively, government expenditure is lower. Private sector capex is slower even as just the top 10 companies are sitting over a cash pile of Rs 5.5 lakh crore. Private consumption is poorer as the desire and ability of consumers is haunted by the cost of living and employment uncertainty visible in shrinking hiring and campus placements.

The net result is that the rate of growth is lower than the rate of inflation. The cliché is money makes the mare go round, fuelling investment, job creation, incomes and consumption. The lack of expenditure, investments, incomes and consumption is dragging down growth. In short, inflationary politics has deflated growth.

A parade of reasons has been offered for lower government expenditure — ranging from the many elections to extreme weather events. It is arguable that there is merit in the arguments, even if only in part.

The villain of the slowdown is poor governance. Analysts have pointed out that state governments have overspent on sops — RBI data reflects the rise in revenue expenditure deployed for freebies — and underspent on projects. A recent report by India Ratings suggests that nearly Rs 62,000 crore of the Rs 11.11 lakh crore for infra may not be spent.

There is unspent money and there is the cost of money. Private consumption accounts for over 61 percent of the GDP, and both access to and cost of money matter for the sustenance of demand. Consumers are facing a double whammy — the crackdown on personal loans and higher interest rates.

The RBI has much to answer for: from its forecasts for GDP growth to inflation targets. In January, the RBI argued that food price inflation was outside its realm, and in August, it argued that it is obliged to bring it down.

Meanwhile, food inflation has averaged above 7 percent for over 18 months. In November, the consumer price index was at 6.2 percent and food price inflation at 10.9 percent. There is much lather about the need for a rate cut. Yes, it will help boost demand, but addressing the slowdown calls for more than a rate cut.

India’s economy requires urgent structural reforms. Households have been forced to rejig budgets to accommodate the rise in food prices. Higher interest rates have scarcely dented the price line. The cause — beyond vagaries of weather and whimsical policies — rests in the inadequacies of availability, storage, distribution and processing. The answers squarely rest in the domain of state governments.

Take employment generation, which calls for active investment promotion. It is no secret that labour laws hinder scaling up of businesses, yet the new labour codes designed in 2019 to ease matters are pending adoption in many states. Add cumbersome and archaic regulatory requirements.

It’s not that the political class is unaware of the faultlines. The innovations visible in the electoral arena are expressions of awareness. The harsh truth is that the electoral algebra favours sops paid for by taxpayers over macro development for employment and growth. In the 1990s, Bill Clinton rode to power on the slogan ‘It’s the economy, stupid’. In the Indian context, the essential cause of the slowdown is, well, the politics!

Shankkar Aiyar, political economy analyst, is author of ‘Accidental India’, ‘Aadhaar: A Biometric History of India’s 12-Digit Revolution’ and ‘The Gated Republic –India’s Public Policy Failures and Private Solutions’.

You can email him at shankkar.aiyar@gmail.com and follow him on X / Twitter @ShankkarAiyar. This column was first published here. His previous columns can be found here.