ExplainSpeaking: What the latest GDP estimates tell about the state of India’s economy

What’s the GDP forecast?

The GDP is essentially the monetary measure of all the goods and services produced within India’s borders in a year. It provides the size of the Indian economy.

According to MoSPI, India’s nominal GDP is expected to be Rs 324 lakh crores by March-end. This is a growth of 9.7 percent over the last financial year (FY24).

The nominal GDP is what is used to arrive at the US dollar equivalent figure for the size of the Indian economy. At an exchange rate of 85 rupees to a dollar, India’s GDP in FY25 will be $3.8 trillion.

It is noteworthy that if India’s exchange rate had not fallen from around 61 rupees to a dollar in 2014 then today India could have boasted of becoming a $5 trillion economy ($5.3 trillion to be exact).

Another noteworthy aspect is that this nominal GDP is lower than the budget estimates presented last February in the Interim Budget (Rs 328 lakh crore) as well as the full Union Budget presented in July (Rs 326 lakh crore).

However, in everyday use, it is the “real” GDP that matters.

The real GDP is derived by removing the effect of inflation from nominal GDP. The nominal GDP of a country can go up either because the country produces more goods and services or because the prices of existing goods and services have gone up (read inflation). More often than not, both these factors lead to an increase in GDP.

The real GDP tells the extent to which India produced more goods and services and it does so by removing the prices at which goods and services are pegged.

According to MoSPI, India’s real GDP will be Rs 184.9 lakh crore in FY25 — that’s just 57% of the nominal GDP; the remaining bit is the effect of prices going up.

Regardless of whether one looks at nominal GDP or real GDP, the data (see TABLE 1) shows that the rate of growth of India’s economic output (GDP) is decelerating. This is not to say that the economic output is falling; only that the rate at which it is growing from one year to another is getting lower.

TABLE 1

Since FY20 (the year before Covid), India’s real GDP has grown at a CAGR (compounded annual growth rate) of just 4.8%. This is in stark contrast to the almost 7% average annual growth rate that India had since the 1991 economic reforms (see CHART 1 sourced from a July 2020 report by McKinsey Global Institute).

CHART 1. Source: A July 2020 report by McKinsey Global Institute

On the nominal GDP front, annual increases of less than 10 percent are in stark contrast to India’s record in the recent past. Between 2003-04 and 2018-19, nominal GDP grew at an average rate of around 13.5 percent.

What’s holding back India’s GDP growth?

GDP is calculated by adding up all the money spent in the economy. To understand this one has to look at the four main categories in which all spending is categorised; these can be seen as the four engines of GDP growth in the economy.

1. Spending by people in their individual capacity: Technically this is called Private Final Consumption Expenditure (PFCE). It accounts for almost 60% of India’s GDP.

2. Spending by governments to meet daily expenditures such as salaries: This is Government Final Consumption Expenditure (GFCE). It is the smallest engine, accounting for around 10% of GDP.

3. Spending towards boosting the productive capacity of the economy (also called investments in this context: This could be in the form of governments making roads, companies building factories or buying computers for their offices etc. This is called Gross Fixed Capital Formation (GFCF), and is the second-largest engine of growth that typically accounts for 30% of the GDP.

4. Net exports or net spending as a result of Indians spending on imports and foreigners spending on Indian exports: Since India typically imports more than it exports, this engine drags down India’s overall GDP, and shows up with a minus sign.

TABLE 2 shows how each of these components have done in absolute and percentage terms.

TABLE 2

PRIVATE CONSUMPTION DEMAND or PFCE: What Indians spend in their personal capacity is the most vital determinant of GDP growth. If this growth rate is low then it not only drags down overall GDP, it also dissuades private sector from investing in the economy. For the current year, this spending is expected to grow by 7.3% but the crucial number in the table is the CAGR of just 4.8% since FY20. If the biggest engine of GDP growth itself is growing at less than 5% it is no surprise that overall GDP growth rate since the start of April 2019 has also been at 4.8%.

GOVERNMENT SPENDING: What distinguishes governments from every other player in the economy is the fact that governments can potentially spend in excess of their incomes; almost all governments do. When the rest of the economy is struggling, governments are expected to borrow money (and/or even print it) and spend it in the manner that re-energises the economy. However, notwithstanding how Covid disrupted the rest of the economy, the government’s own spending has barely grown — just 4.2% in the current year and an average of 3.1% since the start of 2019.

SPENDING TOWARDS PRODUCTIVE CAPACITY: Typically such spending goes up either because private businesses find it profitable to expand capacity (in the hope of selling to the general public) or because governments boost capital expenditure (that is, spending towards physical infrastructure). In the current year, this spending is expected to rise by 6.3% but over a slightly longer period, it has gone up by just 5.3% annually. In fact, as the CAGR calculations show, growth of investments into the economy has been petering out since 2014. This is hardly surprising because unless private consumption rebounds, businesses will not invest in fresh capacity, regardless of tax incentives.

NET EXPORTS: When data for any particular year shows up with a negative sign, it suggests Indians are importing more than they are exporting. In most years, net exports is a negative number. As such, negative growth rates in this category are a good development. For the current year as well as in the recent past, this gap between exports and imports has reduced.

Upshot:

The latest GDP estimates provide a reality check for policymakers and citizens alike. On the face of it, India’s economy has registered world-beating growth rates of GDP since after the Covid pandemic. But, as the data analysis above shows, a large part of India’s recent high growth rates was a statistical illusion created by a low base of GDP, thanks, in turn, to a contraction of GDP in 2020-21.

When one considers a slightly longer period, say by including 2019-20 (the year just before Covid), it becomes clear that India’s real economy is growing at less than 5% per annum — almost half that rate at which it should ideally grow if it wants to become a developed country by 2047.

What should the Union Budget do to boost India’s growth? Share your views and queries at udit.misra@expressindia.com

Happy New Year,

Udit Misra