Declining savings and investments

India’s future growth prospects are dim, too, because of declining trends in other economic indicators.

For example, gross domestic savings and household savings have been steadily declining and so is capital formation (GCF) or investment in the economy. In the past 15 years, the National Accounts Statistics show gross domestic savings have fallen from a high of 37.8% of the GDP in FY08 to 31.4% in FY20 and household savings have fallen from a high of 25.2% of the GDP in FY09 to 19.6 in FY20.

This indicates falling income (less saving) and impoverishment of households – a clear indication of progressively slowing down of the economy that began in the UPA-II. Capital formation (GCF), too, has fallen from a high 42% in FY08 to 27.3% in FY21 – another indicator of a slowing economy as an investment provides growth impetus.

Further, the FIIs have pulled out $21.3 billion in the first five months of 2022 (January to May), the highest ever. The only positive sign is FDI inflows, which have increased by a mere 2% in FY22 over FY21 – from $81.8 billion to $83.6 billion – as per the Department for Promotion of Industry and Internal Trade (DPIIT).

These are bad signs for good growth.

GDP growth to slip much below 7.2%

7.2% GDP growth for FY23 is more likely an overestimation. Here is why.

The RBI’s FY23 growth projection is based on quarterly GDP numbers of FY22 and several assumptions. The quarterly GDP numbers (the fourth quarter’s numbers were released on May 31) are based on formal sector indicators and a small part of the informal sector (like, crop production). The actual GDP size for FY22 (8.7%) is likely much less as the informal sector (nearly half the GDP) has been hit harder by the pandemic than the formal sector. Using formal sector data for the informal sector is surely an exaggeration in GDP estimation for FY22.

As for the RBI’s assumptions in GDP projections, one has already gone wrong by miles. It projected CPI inflation of 5.7% for FY23 in its April monetary policy statement (which had taken into account the war fallout and rising crude prices for months by then). Now it has revised inflation to 6.7% – one percentage point higher. At the same time, its GDP growth projection has fallen by just 0.3 percentage points – from 7.5% in April to 7.2% in June. It should have fallen far more.

Why the RBI should have reduced FY23 growth will be clear from the National Accounts Statistics for FY22. While the CPI inflation for FY22 was 5.5%, the GDP deflator (adjustment for inflation) was much higher at 10.8% – “nominal” GDP growth was 19.5% against “real” GDP growth of 8.7%, the difference accounting for inflation. This shows, that the GDP inflation (deflator) is much higher than the CPI inflation and so the change in the CPI would hit the GDP harder.

Then, the RBI is tightening the money supply, which will slow down growth. The repo rate has already been raised by 90 points and CRR by 50 points in May and June. The repo is expected to go further up later in the year, if not CRR. A higher interest rate slows down growth by directly choking credit-driven economic activities, which is aimed at cutting down demand. This is a global phenomenon.

With global growth projected to go down drastically – from 5.7% to 2.9% – India’s imports and exports would also be adversely impacted. How long the war would continue is not known but many expect it to linger on to 2023. A prolonged war would progressively damage global and India’s growth prospects.

A fall in GDP growth will adversely impact revenue resources.

The revenue receipt of ₹22 lakh crore budgeted for FY23 is 6% more than that of the revised estimates for FY22, while GDP growth for FY23 is 11.1% (nominal) in the 2022 budget. This is unusual (inversion) as revenue collections tend to grow at a faster rate than GDP. A lower revenue collection would then choke government expenditure by that extent.

Further, states’ finances would be under severe stress with the discontinuation of GST Compensation.

The 15th Finance Commission estimated a shortfall in state GST (SGST) at “about ₹7.1 lakh crore” between July 2017 and June 2022. It was this shortfall that was bridged through the GST Compensation. There is no reason to assume that the shortfall will stop from FY23, but there would be no compensation. How will states meet the shortfall? With both central and state short of revenues, fiscal expenditures would come down, and so would the growth.

All these factors would then combine to make a deadly cocktail to hurt growth in FY23.

India may not end up in a recession, as many fear for the U.S. now, but the slowdown of the economy is evident. If at all, it will be a ‘technical recession’ involving two-quarters of a shrinking economy (the global definition of recession). Yet, India’s GDP growth would still be among the highest in the world. The GDP growth is falling from 8.7% in FY22 to a projected 7.2% in FY23. All indicators, presented earlier, point to a sharper fall than a 7.2% growth. The only engine to put a break is government spending (GFCE) but it is too small for that, at 10.7% of the GDP in FY22 – down from 11.3% in FY21. Remember, the economy was on a prolonged slowdown. The GDP growth in the pre-pandemic FY20 was just 3.7% – rapidly sliding from 8.3% in FY17.

Even by assuming that India has fully recovered from the pandemic hit, the growth would still be somewhere closer to the 4% mark rather than to the 7-8% mark. That is because for the past two years, India, like any other country, is fighting to recover from the pandemic setback. The RBI’s assessment says, it would take India 13 years (up to FY35) to recover the pandemic loss, if the ‘real’ GDP grows at 7.5% annually, beginning with FY23.[x] India is already missing that target in FY23 by miles.

In the meanwhile, nothing dramatic has happened during the pandemic to assume that the GDP growth would jump to 6-8% witnessed during FY15-FY19. Hoping for that in FY23 and further would be a shot into the dark.

India in recession

Like the U.S., is India headed towards recession?