How is the Indian economy really doing?

All the heady optimism has overlooked the vulnerable state of the macro-economy. Caution, not complacency, is the more appropriate sentiment for now

A cross-section of opinion, from captains of Indian industry to the Managing Director of the IMF, has been gushing praise for India. For them, India is one of the few bright spots in the global economy, with double-digit GDP growth and a prospect of taking over as the next China.

What should one make of these claims? Is the Indian economy truly booming? The short answer is that the latest data flatters to deceive. The economy is out of the ICU, but its health remains fragile and still needs the doctor’s attention.

Assessing the economy today requires accounting for two factors. First, India is a vast, complex country so the economic signals will always be mixed. For example, the IIP has grown modestly over the past three years even as tax revenues have been surging. Some commentators have suggested ignoring the IIP numbers, on the grounds that there are infirmities in its methodology. But there are always measurement problems, and one can’t respond by ignoring all the data. Instead, one needs to go the other way, looking at a wide variety of reasonably reliable indicators before drawing any conclusions.

Another factor is the distortion induced by the pandemic. Over the past few years, there were periods when the economy contracted sharply, distorting year-on-year comparisons. To avoid this problem, one needs to measure progress in level terms, relative to some base.

With these points in mind consider eight major macro indicators, spanning the different sectors of the economy: GDP, IIP, credit, and tax collections (domestic activity); exports and imports (trade); and vehicle sales, both of four-wheelers and two-wheelers (proxying consumption for different income groups). We show these in Figure 1. Annual numbers are indexed to 100 for the pre-pandemic year 2019-20; the latest quarterly numbers are indexed to the first quarter of 2019-20.  

Three conclusions stand out. First, the latest numbers are unusually disparate. So, there is indeed a problem of interpreting the strength of the recovery.

Second, four measures suggest the recovery has been quite feeble: GDP, IIP, credit, and two-wheeler sales. Within this group, the largest cumulative growth over the past nine quarters is a not-very-large 9 per cent, while the smallest change is a very disappointing -14 per cent.

Third, in contrast, a few indicators have been booming. Real non-oil exports and imports have increased cumulatively by 18 per cent and 24 per cent, respectively. And the centre’s real gross tax revenues (GTR) have surged by 32 per cent.  

How can we explain such contradictory findings? The answer might lie in the deep structural shifts that have occurred over the past few years. The distribution of income has shifted from wages to profits. Activity has shifted from the informal to the formal sector. And employment has favoured skilled workers, as Pranjul Bhandari of HSBC has documented for the export sector.

As a result, the upper-middle class has been able to increase their incomes and consumption, paying more taxes. But poorer groups have had to cut back their consumption. Several indicators suggest this shift, but one clear example comes from the contrast in Figure 1 between the sales of four-wheelers and two-wheelers.

Overall, then, India’s economy has recovered after a long period of ill health. The indicators show that the economy is up and walking. But it is not yet running. In GDP terms, the economy is just 3.8 per cent larger than it was three years ago. And it is worth noting that 2019-20 was a year when the economy was in ICU, with most indicators showing negative growth as Figure 1 shows. Thus, a comparison with the healthier 2018-19 would present a much dimmer picture.

What about the future? Perhaps India is at the starting line for an exceptionally fast sprint? Here, too, there is a need for caution since the global economy is slowing sharply. Over the last two decades, such slowdowns had a mixed impact on India, harming exports but helping incomes by reducing fuel and food prices. But these windfalls might not materialise this time since war and geo-politics may put a floor under commodity prices. Meanwhile, the global slowdown is already hurting exports, the key motor of the recovery so far. So, unless investment revives — and the IIP capital goods and infrastructure index has been stubbornly flat for three years — the recovery might well weaken.

An even bigger challenge, perhaps, is the size of India’s macro imbalances. One of the requirements for an economy to start racing ahead is balance in its key macro variables: its fiscal and current account deficits need to be modest and finance-able; its inflation, low. Without such balance, there is a serious risk that growth will be set back, either because the authorities tighten policies to keep imbalances from spiralling out of control or because adjustment has been delayed and markets have panicked.

So, consider how India fares on a macro-balance index that simply combines these three elements: inflation, fiscal and current account deficits balances (the latter two measured as a share of GDP). One might initially think that the country compares favourably. But the picture turns out to be quite different. Figure 2 shows that when you rank the 20 largest economies (in purchasing power parity dollars) according to this index, India is the second most vulnerable in 2022, according to the IMF’s latest estimates. Only Turkey does worse. These estimates will be revised next month by the IMF and some countries such as the UK might do worse on the index but the thrust of India’s relative vulnerability is unlikely to change dramatically. 

In other words, all the heady optimism has overlooked the vulnerable state of the macro-economy. Headline inflation has been above the target 4 per cent for 35 consecutive months, above the ceiling of 6 per cent for 21 of the 35 months, and core inflation remains close to this ceiling rate. According to the IMF’s latest estimates for 2022, the general government fiscal deficit is almost double-digit, and the current account deficit is 2.9 per cent of GDP. When we compare the macro index to India’s own past, vulnerabilities are at their highest since the fallout from the Global Financial Crisis even if India’s high but depleting foreign exchange reserves provide cushion against real crisis.

India’s opportunities, driven by geopolitics and the slowdown of China, are huge; sustained rapid growth can be achieved. But first the macro stance must be strengthened, with monetary policy tightened, the exchange rate made more flexible, and the budget put on a steady (not aggressive) pace of consolidation. At the same time, as we have argued earlier, the government will need to substantially improve the economic policy software, ensuring: a level playing field for all investors, rule of law, non-arbitrary and inclusive decision-making, policy stability, and social cohesion.

Caution, perhaps even tinged with concern—not complacency— is the more appropriate sentiment for now.

Abhishek Anand is a private sector consultant. Josh Felman is Principal, JH Consulting. Arvind Subramanian is with Brown University and the Center for Global Development