Capex conundrum: Did election-related curbs slow economy in first quarter?

As expected, a lot of people have been giving a lot of explanations for the slower than expected economic growth in the first quarter of this financial year (Q1FY25), and a lot of those explanations point the finger at the model code of conduct (MCC), which was in force because of the parliamentary elections this year. Ostensibly, that slowed government expenditure and pegged back the growth in the gross domestic product (GDP).

Is that all there is to it? Or, are there more nuances? 
 

There are formidable voices expressing the view. Several renowned experts and agencies, including the Reserve Bank of India (RBI), have blamed the MCC for the 6.7 per cent growth in the first quarter — a five-quarter low.

The RBI’s monetary policy committee (MPC) had expected the growth to be 7.1 per cent. Even that would have been a five-quarter low, or the lowest since the 6.2 per cent in the fourth quarter of FY23, which, too, was lower than the RBI’s expectation.

It is also tempting to blame the base effect for the woes of the first quarter this year: In the corresponding quarter of FY24, the GDP had grown at a high 8.2 per cent. But the MPC had factored in the base effect while making its estimates.
 

Further, the growth in the second quarter last year was only a shade lower at 8.1 per cent, but the MPC expects the GDP to grow at 7.2 per cent in the second quarter of this year. For the next quarter — Q3FY25 — the MPC expects the growth to be 7.3 per cent, though the base (Q3FY24) was still higher at 8.6 per cent.

Capex contraction
 

Getting back to the MCC argument, it gets buttressed when one connects it to the slowdown in the capital expenditure (capex) by the Centre and states. For instance, the Centre’s capex was 35 per cent lower during the first quarter of the current financial year compared to the Rs 2.78 trillion during the corresponding period of FY24. To make matters worse, ICRA estimates say the capex by 22 states recorded an annual contraction of 23 per cent during the first quarter of FY25.
 

But, again, what was so striking about this year’s MCC? If this code is the culprit, it should have had a similar slowing effect on the GDP during the earlier election quarters as well. However, if we look at the previous four elections, held since the turn of the century, there is no definitive precedent.

In the first quarter of FY05, which was ruled partially by the Vajpayee government and partially by the Manmohan Singh government, the economy grew at 8.3 per cent, slightly higher than the 8.1 per cent in the preceding quarter.
 

The Vajpayee government at that time took a gamble and advanced the general elections by around six months to April-May of 2004. Since then, the general elections have been held around the same period.
 

In the first quarter of FY10, under the Manmohan Singh government, the economy recorded a three-quarter high growth of 5.9 per cent, reflecting a recovery in the aftermath of the global financial crisis. However, the economy rebounded strongly in the following quarters, with growth rates of 9.3 per cent, 7.7 per cent, and 11.4 per cent.

Similarly, in the first quarter of FY15, which saw a transition from the Manmohan Singh government to the Narendra Modi regime, the economy grew by 8 per cent, marking the highest quarterly growth in the new series (base year 2011-12) at that time. The quarter saw a recovery from the so-called "policy paralysis". Growth further accelerated to 8.7 per cent in the second quarter but moderated to 5.9 per cent and 7.1 per cent in the subsequent quarters.
 

Conversely, the first quarter of FY20 experienced a growth rate of 5 per cent, the lowest in 25 quarters, despite the government introducing schemes such as PM-Kisan Samman Nidhi and announcing tax reliefs before the MCC could kick in. This period is often cited as the one when the  economy started slowing even before the Covid-19 lockdowns arrived in March 2020.
 

Most likely reason
 

Former chief statistician Pronab Sen says the current economic slowdown cannot be attributed to the MCC since historically periods right before elections saw upticks in the growth rates. “The government public expenditure has become significantly more crucial, primarily due to a decline in private investment demand. This shift is largely responsible for the current trend we are observing,” he notes.
 

The capex by the Centre in recent years has increased much more as a proportion of total expenditure as well as the size of the economy and therefore the contraction here played a key role in applying the brakes on the GDP growth rate.
 

Capex as a percentage of total expenditure as well as the size of the economy is pegged much higher during the current financial year than in the years corresponding to the previous three elections. 
 

There is a qualifier here, though: It was almost similar in FY05.  Besides, the capex during the first quarter was much lower at 11 per cent of total capex spent during the entire FY05 than the 16 per cent spent in the first quarter this year (as a percentage of the Budget Estimates for FY25). Even then, the economic growth was a shade higher during the election period that year than the previous quarter — Q4 FY04.
 

However, crucially, the base was quite lower that time than is the case in Q1FY25.
 

Surajit Mazumdar, professor of economics at the Jawaharlal Nehru University, suggests that the slowdown in the economy is a long-term phenomenon that has been perceptible even in the GDP data since the demonetisation. He says the slowdown is most likely greater than suggested by the GDP data.  “Even the 6.7 per cent growth (during Q1FY25) is being derived from a low nominal rate of growth of GDP, presuming that the inflation rate is much lower than it actually is,” he says.
 

The nominal GDP growth decelerated to 9.7 per cent in the first quarter of the current financial year against 9.9 per cent in Q4FY25. The growth had stood at 8.5 per cent in Q1 of FY24.
 

This meant that average deflators (showing inflation rate) were taken as 3 per cent during the first quarter of FY25. These are smaller than the average retail inflation at 4.9 per cent during the period. However, these are higher than the 2.4 per cent average wholesale price inflation during the period. This is so because most of the deflators reflect annual change in wholesale prices of that particular segment.    

Mazumdar argues that if the MCC explains the slowdown, it must be the case that growth is highly sensitive to public expenditure levels. "Hence, instead of being concerned with fiscal deficit and public debt levels, the government should step up levels of public expenditure," he adds.
 

RBI Governor Shaktikanta Das recently said only two aspects had pulled the growth rate slightly down in Q1FY25. "Those are government (both Central and state) expenditure and agriculture… “We would expect the government expenditure to pick up in the coming quarters and provide the required support to growth.”  
 

The farm sector grew by just 2 per cent during Q1 this financial year. Though the growth rate was a four-quarter high, it was lower than the 3.7 per cent in Q1 of FY24.

 

*Election period GDP growth rate, Note: Figures for 2002-03 to 2003-04 are on the base year of 1999-00 and those of 2008-09 and 2009-00 are on the base year of 2004-05, all these figures are growth rates in gross domestic product at factor cost at constant prices, subsequent figures are on the base year of 2011-12 and are growth rates of gross domestic product at market prices at constant prices

Source: RBI,  Business Standard calculations, Mospi