Is it time to brace for turbulence as the Indian economy may not be resilient enough?

Besides the low base factor due to Covid-led hit earlier, what also led to the growth was private consumption or capital expenditure and increase in services on the supply side. Image: Punit Paranjpe / AFP

India accelerated to fast-paced growth in the June-ended quarter, but the economy may still be headed for a slugfest in the second half of the financial year as monsoon plays truant, creating higher food inflation, while government-led spending takes a backseat amid declining exports. What is concerning is if the world’s fastest-growing economy will show its resilience as the country enters election mode in 2024.
 

Showing consistent growth for the second quarter in a row, India’s real gross domestic product (GDP) growth rose to a four-quarter high of 7.8 percent year-on-year in the period between April and June. This compares to a growth of 6.1 percent in the preceding three months ending March. However, it still fell short by 20 basis points (bps) of Reserve Bank of India (RBI) estimates of 8 percent growth even as the real GDP growth was at a four-quarter high in June.
 
Besides the low base factor due to Covid-led hit earlier, what also led to the growth was private consumption or capital expenditure and increase in services on the supply side.
 
It may be time to brace for turbulence as economists feel this may be the peak or end of the higher growth cycle in the Indian economy.  

Dry monsoon: Big risk   

According to Dharmakirti Joshi, chief economist, Crisil, growth is likely to have peaked in the first quarter and is expected to face headwinds. Monsoon is the biggest risk for domestic demand, as it turned deficient in August under the pressure of El Niño. Further weakness in September could mean a hit to rural incomes and rising inflationary pressures.
 
“External demand will remain a drag on growth as western advanced economies undergo a more protracted slowdown with their interest rates staying higher for longer. Also, the lagged impact of 250 basis points rate hike since April 2022 will weigh on demand. However, robust Indian government capex is expected to cushion growth to some extent. Taking these factors into account, we maintain our forecast for real GDP growth at 6 percent for this fiscal,” Joshi explains.
 
During August, monsoon rainfall was lowest in a century, shows India Meteorological Department (IMD) data. During the month, India received 162.7 mm rainfall, which is 36 percent less than its LPA (long period average) 254.9 mm based on data from 1971 to 2020. Rainfall all over India was lowest at 162.7 mm since 1901 against the previous record of 191.2 mm in 2005.
 
Rising risk of El Niño may impact rains and crop yields as reservoir storage levels decline, thereby impacting food inflation which is already increasing. IMD has also warned of El Niño conditions, which may intensity further and continue up to early next year. Currently, weak El Niño conditions are prevailing over the equatorial Pacific region.
 
Joshi adds that easing in the first quarter, retail inflation has resurged in the second quarter, which is likely to soften consumption demand, particularly in the second quarter. Food is the biggest risk to inflation, given the weak monsoon. Rural demand will particularly face the brunt from a hit to incomes from weak crop production and high inflation.
 
Agriculture remains a key risk to overall GDP growth in FY24 as its growth slowed down, while monsoon has been erratic this season.

Also read: Why the rural economy isn't out of the woods yet
 
Base effect in real GDP is likely to continue to play throughout the year and with global growth slowing, GDP growth will witness moderation in the remaining quarters of the fiscal, says Sonal Badhan, economist, Bank of Baroda. Critical factors determining overall growth this year, Badhan points out, will be monsoon activity and its impact on agriculture growth.
 
“High frequency data points (rail freight movement, diesel consumption, air passenger traffic) are showing some easing in Q2 (July-August) so far, compared with the previous quarter. Assuming an overall normal monsoon, and boost from the festive demand, we expect full year growth to settle at 6.3 percent in FY24,” Badhan says.  

Consumption: Festive push?   

Even as economists are pencilling in a pick-up in overall consumption demand, especially during the upcoming festive season, low agricultural income growth due to monsoon is still feared to hit demand.
 
“The upsurge in food inflation could impact consumers’ purchasing power, having implications for the upcoming festive season demand,” says Rajani Sinha, chief economist, Care Ratings.
 
Weather-related uncertainties may hamper agricultural production posing a threat to rural demand recovery and economic growth outlook.
 
“The growth story in the subsequent quarters will, therefore, depend on various factors such as weather-related developments, the government’s effectiveness in taming inflationary pressures, and spillovers from slowing external demand. Nevertheless, with the waning of the base effect, the growth numbers are expected to fall gradually in the coming quarters,” Sinha explains. Therefore, she estimates FY24 GDP projection at 6.5 percent with risks titled towards downside.
 
Economists at Kotak Institutional Equities estimate FY24 GDP growth by 40 bps to 6.2 percent, but they revised down FY25 estimate by 20 bps to 6.3 percent.
 
Most consumer companies have reported weak volume growth in the June-ended quarter which makes economists at Kotak Institutional Equities wary of the consumption profile. “The quarterly profile of GDP has seen some unusual shifts post Covid, making it difficult to evaluate underlying trends, particularly for the June and September quarters,” says Suvodeep Rakshit, senior economist, Kotak Institutional Equities.
 
Rakshit expects some fatigue in demand to set in amid tightening financial conditions, lagged impact of past rate hikes, weather disruptions, and high inflation, early signs of which may show in the festive season.  

Also read: If price shocks persist, we have to act: RBI

Investment growth: Private versus government   

Growth in the first fiscal of FY24 was driven by pick up in private consumption, which jumped to 6 percent in April-June from 2.8 percent in the previous quarter. Private investment slowed, but still clocked growth of 8 percent in Q1 compared to 8.9 percent in Q4. What declined was government consumption which was at -0.7 percent in Q1FY24 versus 2.3 percent in Q4FY23, and exports falling 7.7 percent from 11.9 percent in the previous quarter.
 
Overall, GDP growth in the June-ended quarter remained robust led by higher domestic demand. “On the expenditure side, consumption and investments provided cushion to real GDP growth. However, muted exports and discrepancies are worrisome. On the production side, the services sector remained resilient, but industrial activities grew slowly,” says Nikhil Gupta, economist, Motilal Oswal Financial Services.
 
From April to July, India’s fiscal deficit was at Rs6.06 trillion which is 33.9 percent of the Budgeted Estimates (BE) for FY24, indicating sharply lower-than-the-pre-Covid period average of 80 percent. Gross tax revenue was at Rs8.9 trillion, constituting 26.6 percent of FY24BE. Share of capex in total expenditure doubled to 23 percent versus pre-Covid average of 11 percent.
 
Economic growth of 7.8 percent is despite tight monetary conditions during Q1FY24 and the Reserve Bank of India’s (RBI) estimates indicate that growth will taper as we progress through FY24, says Hitesh Suvarna, analyst, JM Financial Institutional Services. Suvarna thinks risk to growth would emanate from the external sector through weak trade activity and political uncertainty.
 
“On the domestic front, erratic weather-led deficient rainfall may have implications on inflation which could tighten monetary conditions further. However, we continue to believe that the RBI would take a cautious approach and avoid sacrificing growth at this juncture,” Suvarna adds.
 
Last week, the government reduced the price of LPG cylinder by Rs200, following which beneficiaries of Ujjwala scheme will effectively pay Rs700 per cylinder. LPG has a weightage of 1.29 percent in the CPI or retail inflation basket which should ease inflationary pressures, while the subsidy burden may rise to Rs35,200 crore in FY24, as per Suvarna’s estimates.
 
According to economists at Nomura, the key driver of growth—investments—remains dependent on government activism, which will be difficult to sustain towards the end of the year as the election calendar heats up and the government’s fiscal trade-offs increase as it mounts a fiscal defence of inflation. Discretionary consumption demand has been weak, although spending on state elections in the fourth quarter of 2023 and ahead of the general elections in the second half of 2024 could help provide some buffer, Sonal Varma and Aurodeep Nandi, economists at Nomura, say. They have, however, raised 2023 GDP growth projection to 6.3 percent from 5.9 percent previously, and FY24 at 5.9 percent from 5.5 percent previously.
 
According to India Ratings and Research, the Indian economy is at the cusp of a new private corporate capex cycle as analysis of data shows that capex sanctions could lead to a decadal-high capex spend in FY24. While there is a steady uptick in project sanctions across all ticket sizes, there could be a significant push from large projects in this cycle. Besides Uttar Pradesh, Gujarat and Maharashtra, which continue to dominate fresh capex sanctions, Odisha is coming up with projects across textiles, steel and power sectors, it adds.