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Welcome to the EY India Insights podcast. I am your host Tarrung Kapur and today we embark on a journey to unravel the intricate economic tapestry of India's macro-fiscal landscape. In this episode, we deep dive into reasons for India's robust second quarter (Q2) real GDP growth at 7.6%, showcasing the nation's ability to remain a global growth leader not just in the current year, but in the medium term as well.

To facilitate this discussion further, we are joined by Dr. D.K. Srivastava, a distinguished economist, Honorary Professor of the Madras School of Economics and EY India's Chief Policy Advisor. We welcome you, sir, to this podcast. 

Together we dissect the growth numbers to identify factors driving India's growth as well as any challenges that the policy makers should look out for. Let us kick off by understanding the forces driving India's strong economic growth.

Tarrung: Dr. Srivastava, could you please elaborate the factors that have propelled the impressive growth of 7.6%, well above the Reserve Bank of India’s (RBI’s) second quarter estimate? what is your assessment of growth for this year as a whole?

Dr. Srivastava: Thank you so much for having me, Tarrung.

We were all pleasantly surprised by this quarter's growth number. As you know, the RBI estimate was much lower than the actual estimate that we got at 7.6%. If we bring it together with the first quarter (Q1) growth of 7.8%, then we had a first half (H1) growth of 7.7%. This augurs well for the overall annual growth expectation for all of us. In fact, the RBI estimated it at 6.5%. The International Monetary Fund (IMF) had estimated it at 6.3%. I think we are well on our way either to meet the RBI expectation of 6.5% or even exceed it marginally. This growth in the second quarter signals certain important features:

• First, we noticed that it is a very broad-based growth rate. Most of the sectors are showing good robust growth.
• Second, it signals a complete recovery considering the pre-COVID levels of the Indian economy. All sectors have recovered over and above the magnitudes that were recorded in the pre-COVID year of FY20.
• The third good feature is that we have achieved this in spite of a very adverse global set of circumstances. And therefore, this is driven almost entirely by domestic demand.

Within domestic demand, the notable characteristic is that it is the central government which has taken the lead in driving domestic demand. First of all, we read this in terms of the growth in gross fixed capital formation, which is what we sometimes refer to as the investment rate. In the first half (H1) of FY24, this growth is 9.5%, and the union government’s capital expenditure growth is at 43.1% in the first half of this year. This means that the central government had budgeted high growth and most of that expenditure has been front-loaded in the first two quarters of the fiscal year. Also, although not mentioned in the numbers provided by the central government, but we have noted indirectly that the state governments have also been rather positive in terms of supporting capital expenditure of the central government, due to which certain crowding in factors have kicked in. As a result of that, we could find that the sectoral growth rates have picked up because the central government has generated demand which has spread out to the other sectors.

Tarrung: Moving on to sectoral dynamics, I have two questions; first, which segments have performed relatively better? And second, what does this imply for employment prospects?

Dr. Srivastava: Some of the important sectors which have done rather well and if we consider the first half as a whole – Q1 and Q2 together – we notice that manufacturing has grown by 9.3%, construction at 10.5%, and financial, real estate and professional services at 9%. These are high-growth sectors and carry a good weight in the construction of the output of the economy, i.e., gross value added (GVA). 

But in addition, some of the services sectors have also signaled very positive recovery. I would particularly mention two. One is public administration, defense, and other services. This is the sector where central and state government expenditures, particularly on capital expenditures, get recorded. This sector has shown a growth of 7.7%.  

The other sector is trade, hotels, transport, communication, and services related to broadcasting. This is a sector which has a high share in the GVA, just a little less than 20%. This sector has also grown when we consider the first half together at 6.6%. This is important as this is an employment intensive sector, and this sector also suffered the most due to the COVID shock. So, its recovery at 6.6% is a positive sign for the economy and that confirms that the entire economy has recovered from the COVID shock. We also noticed that it is this sector which, in the first quarter, had a magnitude lower than the corresponding magnitude in the pre-COVID year of FY20. It has now recovered fully from that COVID level, which is why I say that all sectors have recovered considering their pre-COVID levels, and the recovery of the economy is not now confirmed as full and complete.

Tarrung: Shifting gears, let us turn our attention to the challenges to growth. In your assessment, what are the key risks in FY2024 for India’s growth prospects?

Dr. Srivastava: I notice three important risks. The first risk emanates from the global conditions within which India is forced to operate. In the global scenario, three crises occurred in quick succession. 

First of all, we had the COVID shock, which led the Indian economy into a contraction. And after that, we had two shocks emanating from the Ukraine-Russia war and later the Israel-Hamas conflict. These two crises also led to a supply-side challenge for the Indian economy. Suffering was more for the rest of the world as the global economy went into a slowdown and some of the developed economies entered into a recession. As a result, India's exports slowed down considerably, and the risk that is now being faced by India is that the contribution of our net exports is going to be negative not only in this year but also in the medium term. We now have to depend almost entirely on domestic factors that will drive growth. These factors have to be stronger enough to not only overcome the negative impact of global factors but also give us positive growth, which is what has happened as per the second quarter (Q2) results.

The second risk is associated with agricultural growth. Agricultural growth in this quarter has been low - at 1.2%. Even if we consider the first half of the year, it is going to be 2.4%. This is a temporary risk caused by a deficient monsoon this year and its uneven spread. But we expect that even if we reach in the range of 2.5% to 3% growth for agriculture, it would still be quite satisfactory since agriculture is known to be cyclical in nature. In fact, if we examine its performance over a longer period of time, we have noted that the agricultural cycle is for about three years on average; that is to say, in three years it goes from peak to peak or trough to trough. Since we have had good agricultural growth in the previous three to four years, it is expected that this year we will have lower growth. But even 2.5% to 3% growth would be satisfactory.

The third risk is associated with something which is not recognized in general as yet, which is that there is a possibility of nominal GDP growth being lower this year, lower than even what was expected in the budget. The budget had expected a 10.5% nominal growth, but nominal growth is actually the outcome of two factors - real GDP growth and implicit price deflator-based inflation. It is the latter that is expected to be low. And the reason is that even though Consumer Price Inflation has been relatively high, it is the Wholesale Price Index (WPI) which is quite low at 0%. We expect that the nominal GDP growth may be close to 9-9.5%, below the expectations that were made in the budget estimates. As a result, there would be a possible impact on tax revenues, but there are other mitigating factors that we shall discuss.

Tarrung: Thank you sir for elaborating the three key risks to India's growth. Taking cue from the last risk that you mentioned, now that we are approaching the interim budget presentation, what are your views on the prospects of achieving the budgeted fiscal deficit target of 5.9% of GDP for FY2024, especially in the light of subdued performance of indirect taxes and expenditure side pressures?

Dr. Srivastava: The positive news on the fiscal side is that our direct taxes are doing very well; both the personal income tax and the corporate income tax. It is, as you say, the indirect taxes that are a cause of concern. But this concern may be overcome by more than expected buoyancy of the direct taxes.

We have data for the first seven months in terms of growth of gross tax revenues of the central government, and that is showing a 14% growth. Within that 14% growth, direct taxes have grown by 24.1%, surpassing the growth in indirect taxes. Within indirect taxes, GST has grown at 8.4%, but it is the Union excise duties which have shrunk by 9.3% (-9.3%). We expect that the fiscal deficit target of 5.9% ( for FY24) would be either met or it might be missed, but by a very small margin.

The reason is that there are certain pressures arising from the subsidy expenditures that were not fully budgeted. We expect that there may be some impact of some of the recent schemes that have been announced by the Government of India, such as the extension of the free food grain scheme and the extra costs that are now being met in the rural employment guarantee scheme (Mahatma Gandhi National Rural Employment Guarantee Act or MGNREGA). Apart from that, the LPG and fertilizer subsidies may also cost extra. Together, we consider the impact of all of these at about INR85,000 crore in addition to what was budgeted.

This may have to be overcome by the extra buoyancy of the direct taxes. There may be revenue side restructuring that may give us scope for adjustment. Our overall assessment is that in spite of these pressures, we may be able to either meet the fiscal deficit target or miss it by a small margin. 

Irrespective of what we achieve in FY24 in terms of fiscal deficit, it is important to continue on the glide path of correction and reach the level of 4.5% in two years’ time. If we are able to achieve, say, 5.2% fiscal deficit in FY25 and 4.5% in FY26, we would still be making satisfactory progress towards showing our intent to meet our fiscal consolidation targets.

Tarrung: My last question for this episode is about a lesser understood aspect relating to the interplay between fiscal discipline and growth. How do you see this panning out in the medium term in the Indian context?

Dr. Srivastava: Fiscal discipline and growth are interlinked in two respects, somewhat directly. First of all, it is the consolidated revenue deficit of central and state governments, which translates into the savings of the overall government sector. If we have a balance on revenue account, we will have these savings that are zero. It is important, therefore, to maintain this fiscal discipline on the revenue account of the budget of the central and state governments because that adds overall to the available resources from which investments can be sourced.

The second consideration is that if we have fiscal deficit along a sustainability path, we are able to contain the burden of interest payments relative to revenue receipts of the governments. If we contain the burden of interest payments, this releases funds for undertaking capital expenditures which will contribute to growth. So, to ensure that we are supporting growth, we need to spend on capital expenditure so that infrastructure can be created and for this purpose we have spelled out a Fiscal Responsibility and Budget Management (FRBM) Act, which has certain targets. According to those targets, if we say that the fiscal responsibility targets are being met, then we will be faced in the market with reasonable interest rate conditions. So, it is important for growth that FRBM targets are met and in fact, FRBM target should be supplemented by a revenue account balance target so that we have relatively higher savings. From higher savings we get higher investment, and that investment gets translated into growth by utilizing an incremental capital output ratio.

For example, if we have a nominal saving rate of 29% and we make certain adjustments and this gets translated into a nominal investment rate of 29%, then we have noticed that the corresponding real investment rate is about 33%. This difference comes about because of the fact that capital goods inflation has kept lower than normal goods inflation and 33% will translate into about 6.5% growth. If only we could add to our overall saving by 2% points, we should be able to maintain a medium-term growth of about 7%. That would be very desirable for our Amrit Kaal growth goals and that would assure the Indian economy onto a medium to long-term growth path and convert our economy into a developed economy.

Tarrung: Thank you very much, Dr. Srivastava, for joining us in this session and providing us your invaluable insights.

Dr. Srivastava: Thank you very much.

Tarrung: Thank you to all our listeners. Stay tuned for more captivating discussions on EY India Insights. Do not forget to subscribe for the latest updates. Until next time, this is Tarrung Kapur signing off.

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