Among the challenges ahead for India, trade is the biggest risk to growth

In an environment of heightened economic uncertainty, the estimate of gross domestic product (GDP) for the first quarter (April-June) this financial year came as a surprise for most economy watchers and forecasters. The official data, released last week, showed the Indian economy expanded 7.8 per cent during the quarter, the highest in five quarters. Gross value added, which is a better indicator of economic activity, expanded by 7.6 per cent. The Reserve Bank of India (RBI) had projected a growth rate of 6.5 per cent for the quarter. However, sustaining this level of growth or achieving the RBI’s full-year projection of 6.5 per cent would be challenging due to the adverse trade environment. 

Nearly all segments of the economy supported growth in the first quarter. The agricultural sector expanded 3.7 per cent, against just 1.5 per cent in the comparable quarter last year. The manufacturing segment recorded a growth rate of 7.7 per cent compared to 7.6 per cent in the first quarter last financial year. The services segment also expanded at a faster rate than last year. Meanwhile, mining and quarrying registered a contraction, while the construction sector showed deceleration. High growth, to an extent, was supported by government expenditure, which went up by 7.4 per cent during the quarter. Government expenditure in the first quarter last financial year had been subdued because of the general elections. This is also reflected in government accounts. The Union government had spent about a quarter of budgeted annual capital expenditure in the first quarter, compared to only about 16 per cent in the same quarter last year. 

While the first-quarter numbers are pleasing, things could become difficult from here on. The biggest risk to growth, of course, is the prohibitive tariff imposed by the United States (US). Estimates suggest that about 66 per cent of Indian exports will face 50 per cent or higher tariffs in the US. The impact on growth will depend on how long this level of tariffs remains in place. If it persists for even a few quarters, employment and domestic demand will start being affected. While the government is reported to be working on addressing the impact, it will be hard to compensate for the potential demand loss. Thus, growth in the coming quarters will, to a large extent, depend on developments in India-US trade relations. Further, growth in the ongoing quarter could be impacted by households postponing buying decisions because of the expected rationalisation in goods and services tax (GST). GST is expected to come down on several goods, including cars, for example. However, this might affect only one quarter’s growth because demand will be back once the GST rates are adjusted. 

Aside from the demand concerns, the other big issue is low nominal growth. At current prices, GDP growth in the first quarter was only 8.8 per cent. Since the inflation rate is likely to remain low in the coming quarters, nominal growth may stay around this level or lower for the rest of the year. Slower nominal GDP growth can make it more difficult to achieve fiscal targets. Reports suggest that the impending GST review could also have a revenue impact, at least in the short run. Thus, the government might have to address multiple emerging issues. It will need to tread carefully in what promises to be a challenging financial year.