Why a growth rate below 5% is a clear and present danger

The government's early estimate sees India's GDP growth dipping to an 11-year low of 5 per cent in the current financial year. Worse, such growth will also mark a deceleration for a third straight year. A consistent slowdown for three years implies that there are bottlenecks in the economy that have not been addressed for a long period of time. A growth rate of just 5 per cent would make it almost impossible for India to achieve the target of becoming a $5-trillion economy by 2024, writes A K Bhattacharya.

A K Bhattacharya , Business Standard
14th January

The first advance estimates of growth in India’s gross domestic product (GDP) for 2019-20 have serious implications for the Indian economy and, therefore, they present many tough challenges.

At 5 per cent, GDP growth in the current year would be an 11-year low. Worse, this will also mark a deceleration for a third straight year.

But why is this slowdown serious?

The last time growth hit a level lower than 5 per cent was in 2008-09, when GDP grew by 3.1 per cent. That drop in the growth rate, from 7.7 per cent in 2007-08, was attributed to the global financial meltdown that became manifest through the Lehman Brothers collapse in September 2008.

Weakness within

Today, there are some problems with international trade, but no similar global headwinds that pulled down India’s growth rate in 2008-09. Yet, India’s growth rate in 2019-20 will drop to 5 per cent, down from 6.8 per cent in 2018-19. So, the problem now is not external. The weaknesses in the Indian economy are largely induced from within, unlike in 2008-09. That is the first big cause for worry.

Two, never in the two decades of this century has the Indian economy’s growth rate fallen for three years in a row. This suggests that the pace of the economy has been consistently moving southwards for as long as 36 months.

A consistent slowdown for three years also implies that there are serious bottlenecks in the economy that have not been addressed for a long period of time and the recovery from such a situation could be an equally long-drawn process.

Three, most of the ingredients of an economy that usually help boost growth have performed below their potential in the current year so far. Gross capital formation, which indicates investment rate, has maintained a tepid growth rate. Manufacturing and constructions sectors have shown a significant slowdown. Chances of a growth recovery will look remote until and unless the investment rate picks up and there is renewed vigour in both manufacturing and construction activities.

Four, a growth rate of just 5 per cent would also make it almost impossible for India to achieve the target of becoming a $5-trillion economy by 2024. Remember that the nominal growth rate is expected to be only 7.5 per cent in 2019-20, down sharply from 11.2 per cent in 2018-19. The growth targets for the coming three years, therefore, would have to become even higher if the goal set by Prime Minister Narendra Modi has to be achieved.

And five, there are serious doubts about the Indian economy’s GDP growth actually touching the 5 per cent mark in the current year. In the first two quarters of 2019-20, the GDP growth rates were 5 per cent and 4.5 per cent, respectively. In other words, the first half of the current year clocked a growth rate of 4.75 per cent.

If the full year’s growth rate has to reach the projected level of 5 per cent, GDP growth in the remaining two quarters should be at least 5.25 per cent each. This will require some acceleration in the second half of the year. The signals so far in the third quarter of the economy have not been encouraging.

What the economy signals

Industrial output, as measured by the Industrial Index of Production, declined by 4 per cent in October 2019 and recovered marginally by recording a rise of 1.8 per cent in the following month. Prospects of industrial growth in December do not look very encouraging. Other high-frequency data including those on passenger vehicle sales, electricity consumption and freight movements during the October-December 2019 period do not indicate any sharp uptick over the second quarter of the current year.

Any growth number below 5.25 per cent for the third quarter of the current year would imply that the fourth quarter growth rate would have to be much higher to make good the shortfall sustained in the previous quarter. The target of 5.25 per cent in the fourth quarter would have to be revised upwards. But meeting a higher growth rate target would be a difficult task.

An underlying assumption of the first advance estimates of GDP growth for 2019-20 is that government expenditure would continue to maintain a healthy rise right through the year. For instance, government final consumption expenditure or GFCE is expected to grow by 10.5 per cent in 2019-20, higher than the 9.25 per cent increase seen in 2018-19. Similarly, expenditure on public administration (which broadly corresponds to government spending) is expected to grow by 9.1 per cent in 2019-20, compared with 8.6 per cent in 2018-19.

Spend and grow?

In other words, the 5 per cent growth projection is critically premised on the government continuing to spend in the last two quarters of the year. But will that be possible?

The government has already put in place a new expenditure management framework that will ensure that there is an effective cut in its expenditure in the last quarter. The range of the cut is not specified. But there are reports that the total cut in expenditure could be in the region of Rs 2 trillion, which would be about 7 per cent of the government’s total annual expenditure. Such a squeeze on government expenditure in the last quarter of the year would certainly have an adverse impact on the overall GDP growth rate for the year.

Already, government expenditure accounts for a little less than half of the GDP growth rates recorded in the first half of the current year. If there is a cut in government expenditure, needed for meeting the fiscal deficit target or even reducing the slippage in the fiscal consolidation programme, GDP growth in the second half of the year too would be affected.

The big worry facing the government would be if India’s economy fails to grow by even 5 per cent, as projected in the first advance estimates. In the first two decades of the current century, India’s GDP growth remained below the 5 per cent mark only on four occasions – 3.84 per cent in 2000-01, 4.82 per cent in 2001-02, 3.8 per cent in 2002-03 and 3.1 per cent in 2008-09.

Will 2019-20 be the fifth time in the last twenty years that the Indian economy would grow at a rate below 5 per cent? Whether the Indian economy’s growth crosses the 5 per cent mark or stays below it, there is little doubt that the tasks before the government will become even more onerous and challenging in the coming months.

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