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Why Indian Economy is slowing down?

What are the issues facing Indian Economy?

  • COVID pandemic has pulled down the global economy and India’s economy is one of the worst affected among them.

  • In the first quarter of the financial year (April-June), India’s economy had contracted by an unprecedented 23.9%. Whereas in the second quarter, after a bit improvement, economy contracted by 7.5%, less than the anticipation.

  • With the result of 2nd quarter, India has slipped into the Technical recession, which requires economy to be negative or declining for two consecutive quarters or more.

  • Although some economist argue that when growth rate is measured on quarterly basis, instead of year-on-year basis, India’s GDP plunged 25 per cent in 2Q20 and recovered by 21 per cent in 3Q20. Thus, India’s economy is not in the technical recession.

How to calculate GDP using Expenditure method?

Final goods and services produced in a country during a period of time are taken into account under expenditure method of calculating National Income or Gross Domestic Product. In this method final expenditure made by each stakeholder is taken into account.

Final expenditure is that part of expenditure which is undertaken not for intermediate purposes.

Following is the formula for calculating GDP by expenditure method;

GDP = C + I + G + (X − M)

  1. C (Consumption) represents the consumption expenditure by the households on Final goods and services, known as Private Final Consumption Expenditure (PFCE).

PFCE is the biggest component of the GDP and constitute around 55-57% of the GDP.

2. I (Investment) represents business investment on equipment. It includes Gross Fixed Capital Formation (GFCF) and Inventory.

  • GFCF includes Investment made in the long-term assets by government and private sector and investment in residential units by business or households.

  • Inventory investment includes investment for procuring raw materials and finished or unfinished goods.

Investment constitute around 30-32% of the GDP.

GFCF Includes investments from Government, Businesses and households. 25% of I is constituted by government investment (Centre, states and PSUs) and 35-40% each is that by the corporate (India Inc.) and non-corporate (MSMEs and household investment in real estate) private sector.

3. G (Government) represents sum of government expenditures on final goods and services including salaries, weapons, investments, etc., also known as Government Final Consumption Expenditure (GFCE).

It doesn’t include the investment in financial products.

GFCE constitute around 10-12% of India’s GDP.

4. X represents gross exports and M represents gross imports. Balance of both is called net exports.

What are the causes behind falling GDP growth?

Demand related issues (PFCE)

  • Consumer demand is falling in urban India. Sales of domestic cars and commercial vehicles are on decline even before COVID pandemic. More than 2.1 crore individuals have lost salaried jobs due to the pandemic since April, and economists estimate the number to increase in future as companies struggle to run smoothly.

  • While many of those didn’t lose their jobs, saw their salaries drastically reduced.

  • Wage growth rate in rural area has declined to a new low. 10 million more rural households are seeking MGNREGA employment per month since August compared to a year ago.

Effect on the GDP

  • Fall in income of households is leading to drastic fall in aggregate demand for goods and services i.e. Private Final Consumption Expenditure (PFCE). PFCE remains in the negative territory, at -11.3% in Q2. Private consumption demand, is the mainstay of the economy as it contributes around 55-60% of GDP.

  • Loans for households are although easily available after government stimulus package, but due to uncertainty of the future income and savings, people are apprehensive of taking loans at present.

Investment and supply related issues (GFCF)

  • Growth rate in eight core sectors is sluggish. That means even if the demand is improving industries will not be in the position to meet those demands.

  • As per All India Manufacturers Organization’s June survey, about one-third of small and medium-sized enterprises indicated that their businesses were beyond saving.

  • Unorganised sector, which is specifically dependent upon daily cash flows and lacking organised fund sources like loans and finance from the institutions, has been badly affected. This sector was already badly affected by demonetisation and GST, COVID pandemic has reduced the possibility of revival of many firms working in this sector.

Impact on the GDP

  • Gross Fixed Capital Formation (as % of GDP) had been on a constant decline (except in 2018) between 2014 and 2019, falling from 30.1% to 27.4%. In Financial year of 2020-21, GFCF was contracted by 7.3% in Q2, compared to 47.1% in Q1.

Government expenditure related issues (GFCE)

  • The central government’s total expenditure (both revenue and capital) has been declining sharply since 2010-11. From a high of 15.4% of the GDP in 2010-11, the total expenditure has hit a low of 12.2% of the GDP in 2018-19.

  • The capital expenditure component has dropped from 2% of the GDP in 2010-11 to 1.6% in 2018-19 and that of the revenue expenditure from 13.4% in 2010-11 to 10.6% in 2018-19.

  • This decline in expenditure is driven by the government’s priority to contain fiscal deficit.

Impact on the GDP

  • Most worrying part for economy is a fall in government spending. Although government has announced stimulus package for revival of economy, but actual fiscal support has not been commensurate as expected. Government-Fixed Capital Expenditure (GFCE) growth has declined by 22.2% in 2nd quarter after improvement of 16% in the first Quarter.

Why government is not able to provide direct fiscal support?

  • Centre’s net revenue (tax and non-tax) collection for the first half of this fiscal is merely 27.3 per cent of the budget for the full fiscal year.

  • Center’s capital expenditure has registered a decline of 11.6 per cent. Capital expenditure is defined as the money spent on the acquisition of assets as well as fresh investments

  • Market borrowings of both the Centre’s as well as the states’ have increased by 50 per cent year-on-year basis. Due to that India’s public debt/GDP will likely reach around 85 per cent. High debt-servicing costs will further crowd out productive public expenditure.

  • Central government fiscal deficit is also inflating.

Why there is a need of direct income support from the government?

Although government has announced stimulus package for revival of the economy that includes benefits for industries, poor people and MSMEs etc., however all these benefits may not be able to provide economy with the immediate boost required at this point of time;

  • At times of slowdown in industrialised economies, there is idle productive capacity on the one hand and unemployed manpower on the other.

  • Unemployment reduces the purchasing power capacity of the households, resulting in low aggregate demand.

  • Increase in Government expenditure or investment on infrastructure lead to expansion of productive capacity and generate long-term economic growth.

  • While the infrastructure spending and reforms are critical to sustain medium and long term growth, neither can boost near-term demand. A stimulus package focused on giving direct benefits to the middle-class could help alleviate the situation.

  • Increase in direct benefit transfers to people lead to immediate increase in aggregate demand of household for goods and services. Increase in aggregate demand leads to fuller utilization of the existing productive ca­pacity and employment generation.

  • Thus, Fiscal spending (government expenditure), as against fiscal conservatism, is favoured because this can be mobilised quickly to deliver results in a shorter timespan while others need longer timeframes to get activated and deliver.

  • Bank recapitalisation for increasing credit flow in the economy is another way to boost demand in the economy.

Way forward

Present time demands government to discontinue its fiscal conservatism approach centred on reducing its fiscal deficit. It is the time to boost the domestic demand by transferring direct benefits, as was done during the 2008 economic recession. Indian economy at that time proved to be resilient and performed far better compared to many developed countries at that time.

Private sector in India is not lacking funds as is the popular perception. It is the lack of confidence in the Indian economy and industries at present that investment in India are reducing. There are sufficient funds available for the government borrowings in the market.


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