After recording a growth rate of over 7 per cent for three consecutive fiscals, the Indian economy appears to have come to a halt.
With projections of easing inflation and Finance Ministry’s Sanjay Malhotra assuming charge as the new RBI Governor, there is cautious optimism that both entities might align their approaches moving forward
After recording a growth rate of over 7 per cent for three consecutive fiscals, the Indian economy appears to have come to a halt.
It grew at a seven-quarter low of 5.4 per cent during the second quarter of the current financial year, down from 6.7 per cent in the first quarter. This slowdown, economists say was primarily driven by weaker manufacturing and private consumption.
Private consumption, which constitutes 60 per cent of India’s gross domestic product (GDP), has slowed to a 6 per cent growth, down from 7.4 per cent in the previous quarter. Notably, even when the economy grew at an impressive 8.2 per cent in the previous fiscal, consumption lagged severely behind at 4 per cent.
Dhiraj Nim, Economist at ANZ, notes that the current consumption slowdown is primarily affecting urban India, and the future trajectory remains bleak.
"The aggregate wage growth has moderated, and with corporate earnings under pressure, there's little reason to expect substantial upside in wage growth within the formal sector going forward," Nim stated.
A recent report by the Federation of Indian Chambers of Commerce and Industry (FICCI) and Quess Corp highlighted the issue of stagnant income, identifying it as a major factor behind the slowdown in demand. The report, assessed by The Indian Express newspaper, emphasised that, despite a fourfold increase in corporate profits over the past four years, income growth within the corporate sector has remained in the single digits.
The compounded annual wage growth rate between 2019 and 2023 was 0.8 per cent in the engineering, manufacturing, process, and infrastructure (EMPI) sectors, while it was higher at 5.4 per cent in the fast-moving consumer goods (FMCG) sector.
Earlier this month, Chief Economic Advisor (CEA) V. Anantha Nageswaran expressed concerns over the low wages paid by India Inc. to their employees, calling it "self-destructive." He warned that this could negatively impact consumer demand and urged companies to reconsider their wage structures.
Notably, the wages are stagnant at a time when retail inflation in India had grown at an annual average rate of 5.7 per cent over the past five years, the report said. India’s retail inflation came at 5.48 per cent in November, after surpassing the Reserve Bank of India’s (RBI) upper tolerance band of 6 per cent in October.
With companies focusing on maximising profits, Indian policymakers are under immense pressure.
Two major fiscal policy events are set to take place in the coming months: the 55th GST (Goods and Services Tax) Council meeting in December and the Union Budget for 2025-26 in February. While both hold the potential to stimulate consumption in India, the question remains: can they deliver?
There is a long-due call to rationalize the GST rates. Currently, GST is applicable in five slabs: nil, 5 per cent, 12 per cent, 18 per cent, and 28 per cent. Essential and semi-essential commodities primarily belong to the slabs between nil and 18 per cent.
In addition, taxpayers are eagerly awaiting the Union Budget, hoping for direct tax revisions that could help ease financial burdens. Nim notes, "I think there is scope for policies to support it, and from a fiscal policy perspective, tax relief for the middle class could help spur consumption a bit more.”
However, speaking on direct taxes, Sunil Kumar Sinha, professor of economics at the Institute for Development and Communication in Chandigarh, says that the correlation between tax reductions and increased spending may not be that direct. “Income tax benefits will primarily benefit households in the lower 50 percent of the income bracket. They are more likely to spend, as their propensity to save is very low. Yet it is hard to predict what will happen after a tax reduction as it completely depends on the understanding of the household whether they choose to spend or save looking at the future,” he explains.
Dipti Deshpande, principal economist at Crisil Limited, shares Sinha’s concerns, noting, “A reduction in personal income taxes can boost household consumption, but only if the increased disposable income is spent rather than saved or used to pay down debt.”
Sinha points that the government might be cautioned after what happened with tax concessions to the corporate sector in 2019. In 2019, Finance Minister Nirmala Sitharaman rationalized corporate taxes, aiming to reduce the tax burden on companies. The expectation was that businesses would use the savings to boost their capital expenditure, but this did not materialize.
The Finance Ministry has clearly learnt its lessons. “Personally, I am not in favour of directly stimulating consumption by stimulating consumption itself. I believe we should focus on stimulating incomes through growth. When incomes rise, consumption will follow,” former Finance Secretary TV Somanathan had told Outlook Business in an interview.
Somanathan added, “Short-term or accidental increases in consumption through government interventions are not sustainable. Simply dropping cash into someone’s hands often results in savings rather than consumption, as economic literature suggests.”
On the indirect tax front, a senior Finance Ministry official recently said that the average GST rate is on a declining trend, leading to reduced government revenue. As a result, the process of rationalising GST rates may take additional time to strike a balance between maintaining government revenue and minimising the burden on taxpayers.
Given the limitations and uncertainty of fiscal measures, eyes are also set on India’s central bank.
While striking an optimistic note, Deshpande says that food inflation is expected to ease in the coming months, which could provide room for the RBI’s Monetary Policy Committee to lower interest rates to increase spending in the country.
The Finance Ministry and the RBI are currently at odds over India’s slowing growth rate and rising inflation. The ministry argues that it is time for the central bank to lower the repo rate, which currently stands at 6.5 per cent. However, the RBI maintains that its primary focus remains on inflation, which continues to exceed their target of 4 per cent.
With projections of easing inflation and Finance Ministry’s Sanjay Malhotra assuming charge as the new RBI Governor, there is cautious optimism that both entities might align their approaches moving forward. Nevertheless, in the current situation, any policy measure would only be a win if it is able to persuade the corporate sector to ramp up investments or to encourage Indian households to spend more.