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Tuesday, August 09, 2022

Explained: How are the fundamentals of the Indian economy?

After his meeting with economists, the Prime Minister underscored the strength of the basic fundamentals of the economy. What does it mean? And what is India's status?

Written by Udit Misra , Edited by Explained Desk |
Updated: January 10, 2020 5:15:01 pm
The data on most variables that one may call as fundamentals of the Indian economy are struggling. Prime Minister Narendra Modi at Assocham, New Delhi. Express Photo by Tashi Tobgyal

On Thursday, after a two-hour-long meeting with a whole host of economists, sectoral experts and entrepreneurs, Prime Minister Narendra Modi sounded sanguine about the Indian economy recovering from hitting a 42-year low in terms of nominal gross domestic product growth rate.

“The strong absorbent capacity of the Indian economy shows the strength of basic fundamentals of the Indian economy and its capacity to bounce back,” he said adding sectors like tourism, urban development, infrastructure, and agri-based industry have a great potential to take forward the economy and for employment generation.

The PM’s meeting and his statement on Thursday were significant not only because they happen in the run-up to the Union Budget, which will be presented on February 1, but also because, once again, the Indian economy is being seen to be faltering.

The first advance estimates of national income for the current financial year, released earlier in the week, found that nominal GDP was expected to grow at just 7.5% in 2019-20. This is the lowest since 1978. Real GDP is calculated after deducting the rate of inflation from the nominal GDP growth rate. So, if for argument sake, the inflation for this financial year is 4%, then the real GDP growth would be just 3.5%.

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Just for perspective, the Union Budget presented in July 2019 expected a real GDP growth of 8% to 8.5% and a nominal GDP growth of 12% to 12.5%, with a 4% inflation level.

What is the significance of the phrase ‘fundamentals of the economy are strong’?

The PM has reiterated a phrase of reassurance — underscoring the strong fundamentals of the Indian economy — that has been often used by policymakers in the past when the economy is seen to be faltering.

For instance, in October 2017, then Finance Minister Arun Jaitley brushed aside queries of the strains on economic growth by repeating this phrase. Earlier, during the sharp dip in GDP growth rate in 2013, both Prime Minister Manmohan Singh and Finance Minister P Chidambaram reiterated that the same phrase.

Globally, too, this phrase is a boilerplate.

One of the most infamous use of this phrase happened when on the morning of September 15, 2008 — the day Lehman Brothers (one of the most well-respected Wall Street brokerage firms) collapsed and unequivocally declared the Great Financial Crisis — then Republican Presidential candidate, Late John McCain reportedly stated that the fundamentals of the US economy are strong.

Roughly a year before that, in December 2007, then US President George W Bush told Reuters that “the country’s economic fundamentals were strong despite ‘headwinds’ from a weaker housing market, and he voiced confidence in a plan to ease the subprime mortgage crisis”.

So, what are the ‘fundamentals of an economy’?

When one talks about the fundamentals of an economy, one wants to look at economy-wide variables such as the overall GDP growth (real and or nominal), the overall unemployment rate, the level of fiscal deficit, the valuation of a country’s currency against the US dollar, the savings and investment rates in an economy, the rate of inflation, the current account balance, the trade balance etc.

There is intuitive wisdom in looking at these “fundamentals” of an economy when it goes through a tough phase. Such an analysis, when done honestly, can give a sense of how deep the strain in an economy run. It can answer the question whether the current crisis just an exaggerated response to a sectoral problem or is there something more “fundamentally” wrong with the economy that needs urgent attention and “structural” reform.

A spike in a 30-stock index, such as the BSE Sensex, could be misleading if it is out of tune with the GDP rate. Looking at a broader stock index, say a BSE500, may add to the picture. Similarly, comparing the growth of high-end cars to the slump in demand for cheap biscuit packets is also of limited analytical value. That’s because these high and lows may largely be due to some sector-specific factor, not an economy-wide factor.

To be sure about the broader health of the economy, one must look at the broader variables. That way, one reduces the chances of getting the diagnosis wrong.

So, what is the current state of the fundamentals of the Indian economy?

The data on most variables that one may call as fundamentals of the Indian economy are struggling.

Growth rate — both nominal and real — has decelerated sharply; now trending at multi-decade lows. Gross Value Added, which maps economic growth by looking at the incomes-generated is even lower; and its weakness in across most of the sectors that traditionally generated high levels of employment.

Inflation is up but the consolation is that the spike is largely due to transient factors. However, a US-Iran type of conflagration could result is a sharp hike in oil prices and, as such, domestic inflation may rise in the medium term.

Unemployment is also at the highest in several decades. According to some calculations, between 2012 and 2018, India witnessed a decline in the absolute number of employed people — the first instance in India’s history.

Fiscal deficit, which is proxy for the health of government finances, is on paper within reasonable bounds but over the years, the credibility of this number has come into question. Many, including the CAG, has opined that the actual fiscal deficit is much higher than what is officially accepted.

Bucking the trend, the current account deficit, is in a much better state but trade weakness continues as do the weakness of the rupee against the dollar; although on the rupee-dollar issue, a case can be made that the rupee is still overvalued and thus hurting India’s exports.

Similarly, while the benchmark stock indices have run up, and grabbed all attention, the broader stock indices like the BSE500 have struggled.

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First published on: 10-01-2020 at 01:02:48 pm
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