The questions for policymakers

What is the state of the economy, and the implications for policy?

Let’s summarise the state of the economy:
 

1. Given the difficulties of the gross domestic product (GDP) data, it’s useful to look at the firm data to understand the state of the economy. There is a small dataset of 508 non-financial firms where the full-year results of 2023-24 are observed; this shows revenue growth of 4.46 per cent nominal.
 

Turning to the quarterly revenue data for the listed firms, there are three quarters with ample data (September 2023, December 2023, and March 2024) and where revenue growth was -0.9 per cent, 2.1 per cent, and 5.0 per cent nominal. There is a small dataset of 176 firms with the data for the June 2024 quarter, and the growth rate seen there was 4.3 per cent nominal.
 

2. In the inflation data, there were brief peaks in headline inflation (year-on-year consumer price index growth) of about 7 per cent in 2022 and 2023. From the middle of 2023 onwards, the headline inflation rate has declined and fallen within the range required in the target range specified in the Reserve Bank of India Act of 4-6 per cent. In the seasonally adjusted core inflation data, there has been a deceleration from 2022 to 2024. When the inflation rate decelerates and nominal interest rates hold still, real interest rates go up.
 

Debt dynamics in many firms have become adverse (in what is termed an “r-g problem”) where the top line has grown (with values like 4.3 per cent, -0.9 per cent, 2.1 per cent, 5 per cent, 4.3 per cent) at values below the cost of borrowing. Numerous Indian firms have responded to the difficulties of 2011-24 by reducing leverage, and for them, this issue is not relevant. But there is a class of firms with debt where this dynamic weighs on the mind.
 

3. There are gains in private investment in the sense that the long decline in the level of projects under implementation (in real terms from 2011 onwards) reached a turning point in 2020-21. It feels good to see that a turning-point was achieved, but the gains are not yet large when expressed in real terms. In real terms, the stock of under-implementation projects is at the level seen in 2008.
 

When we turn to the data for the year-on-year growth of net fixed assets in the private non-financial firms, there was nominal growth of 2.43 per cent in the pandemic year of 2020-21, but in the following years we only got 4.49 per cent in 2021-22 and 4.96 per cent in 2022-23 in nominal terms. For 2023-24, there is data for only 508 firms, and growth in net fixed assets was 4.27 per cent nominal. All the nominal growth rates seen here — 2.43 per cent, 4.49 per cent, 4.96 per cent, and 4.27 per cent — suggest a poor pace of investment.
 

4. The good measure of export, which is observed at a monthly frequency, is export excluding oil and gold. This jumped from a pre-pandemic (stagnant) value of $40 billion a month to a post-pandemic level of $55 billion a month, which was reached in early 2022. After that, there has been sluggish growth to the latest values of about $60 billion a month. These are nominal dollar values; when converted into real dollars, the growth rates after 2022 are near zero.
 

There are considerable global difficulties. Russia’s invasion of Ukraine is the largest high-intensity war after the Second World War. There is the transition into the “third globalisation” where the world economy is seeking to decouple from China, Russia, Iran, and North Korea. Populist politics has been thwarted in some important countries (Brazil, the United Kingdom, France, Poland), but the most important final exam in the United States will come in November. Services export is the engine of Indian export growth, but this will go through some turbulence in digesting new technological developments. With these factors in play, it will be difficult to get high growth in Indian export under present policies.
 

There is a certain consistency in the picture as seen in these four elements, which encourages us to think this is a relatively correct assessment. This, then, is the macroeconomic situation which must be parsed by private and government decision makers. Strategy formulation in private firms and in government organisations needs to parse this information and construct optimal strategies. It also constitutes the backdrop against which we will obtain a next Budget announcement in a few days.

What can policymakers do? Budget making in India is harder, given the lack of trusted national accounts data. The firm data recommends cautious plans for tax revenues and deficits. Reducing tax rates would be one element in helping to improve the post-tax returns on private investment. The central problem that has given us poor private investment after 2011 is the mistrust of private persons, which calls for an array of policy changes reining in central planning and improving the rule of law.
 

There is a contradiction between the return of a near-fixed exchange rate, from 2022 onwards, and the prime purpose of the Reserve Bank of India being inflation targeting. It would be better to getback to a flexible exchange rate, which might create space for lower interest rates without needing to defend the rupee.
 

The external picture features the third globalisation and the problem of Chinese over-production. This calls for reorienting foreign policy and care on imports from China. Information technology/information technology-enabled services are India’s most important industry. This goes into Western markets and often happens through Western companies. This calls for commensurate respect in the engagement with these countries.
 

The Indian average tariff needs to get down to the 1 or 2 per cent value seen in Southeast Asian countries, which have gained from the third globalisation, such as Vietnam. Many non-tariff protectionist measures need to be reversed. It is better to solve disabilities of operating in India (for example, the working of goods and services tax or the capital controls) than to pay out production-linked incentives.

The writer is a researcher at XKDR Forum