On 29th November 2024, the National Statistics Office released data that revealed that the Indian economy drastically missed the growth expectations in Q2. ^[1] In the July to September period, the growth was a lowly 5.4 percent as against the Reuters-polled economists’ expectation of 6.5 percent. ^[2] The RBI expectation was an ambitious 7 percent making it a wider miss. ^[3] The unexpectedly steep decline prompted RBI to revise its GDP projection for the year from 7.2 percent to 6.5 percent. It also made an upward revision of the inflation estimate for the year from 4.5 percent to 4.8 percent. ^[4] It’s not often that macro-economic data deviates considerably from the anticipated figures in the absence of unexpected situations like pandemic or war. The inflation spike in September and October was led by an increase in food prices. ^[5] The inflation in October breached the central bank’s target ceiling and surged to 6.2 percent. ^[6] With economic growth declining and inflation increasing, there have been speculations among the investor community and policy-makers on whether the Q2 growth and recent inflation figures are mere temporary phenomena or a long-term problem.

Private and Public Investments

Investors & economic commentators who anxiously hope that Q2 is an aberration point to the fact that a slowdown in capital expenditure at both central and state levels weighed on the growth. Data from the Controller General of Accounts (CGA) suggests that central government’s capex utilization stood at 37.3 percent by the end of Q2FY25 while the corresponding percentage was 49 percent in the same period of last financial year. ^[7] Government capex expected to fuel growth in the first half saw a steep decline of 15 per cent and 11 percent in central and consolidated state capex respectively impacting the overall growth. It is evident that government spending or lack of it is a significant contributor to the seven-quarter low GDP. ^[8] The government cannot continue high capex investments indefinitely and will have to continue its focus on trimming the fiscal deficit. The fall in Q2 wouldn’t have happened or could have been a one-off incident if private investments picks up sufficiently to offset the decline.

The recent corporate earnings of top companies suggest that private investment won’t be picking up over the next few quarters. A slowdown in private investments remains concerning because leading firms reported their worst quarterly performance in over four years. ^[9] Most corporate giants are likely in cautious optimism mode rather than splurging heavily on capex investments. In the financial year's initial stages, companies postponed their long-term expenditure waiting for the election results to determine the business environment and political situation. Major project announcements had to be postponed by government agencies owing to the model code of conduct during the Lok Sabha polls. Moreover, Maharashtra, the leading state in terms of GDP had model code kicking-in again as the State legislature elections were due. Despite the impending election season, Maharashtra has consistently remained the top destination for investors with 661 projects worth 2.81 lakh crores. ^[10] Now that the dust has settled on the election results at the Centre and State, the contours of private investments will be visible in the upcoming quarters. If private consumption significantly outpaces the overall GDP growth rate as it didn’t in Q2 with just a 6% surge, second-quarter may qualify as a temporary deviation. ^[11]

Dollar and Demand

Conventional wisdom suggests that Central Banks will rein in the inflation by hiking the interest rates. Inflation had gone above the central bank ceiling of 6 percent in October. However, the market is expecting a rate cut in February because RBI also has another problem to deal with – the US Dollar. The Indian rupee touched an all-time low of 84.84 against the US dollar today on 11th December 2024 amid speculation of a rate cut under the new governor. ^[12] A rising dollar and higher crude prices are no less important considerations for the central bank because India is a major importer of petroleum products that power our economy with essential fuels. If transportation costs rise due to expensive petrol and diesel, it will have a direct effect on inflation. Apart from that, optics of a weak local currency doesn’t favor the political establishment. The rupee has been weakening and regularly hitting fresh all-time lows leading to negative economic sentiments at home. ^[13], ^[14]

While the central bank faces the inflation-dollar dilemma, the government is concerned about demand not picking up. Demand has languished among the urban middle class with consumers cutting down on everything from cars to soaps. Inflation-adjusted employment costs for listed non-financial companies — a proxy for real urban wages — declined 0.5% from July to September from a year ago. ^[15] FMCG (Fast Moving Capital Goods)bellwether companies posted lesser-than-expected demand suggesting economic distress at the structural level. Higher input costs have squeezed their margins and fresh bouts of inflation is likely when FMCG giants pass on the costs on everything from coffee to palm oil. Fortunately, volume sales for household items like edible oil, spices, atta, toothpaste, rice and pulses haven’t decreased even in the July to September quarter. There is a possibility that growth may bounce back rapidly as consumers haven’t chosen to downgrade on essentials. ^[16]

Gold and Cars

Gold is an asset class that holds great sentimental value in Indian society. So much so that back in 1991 when the Indian economy faced the balance of payment crisis, the government under Chandrashekhar attempted that airlifting of gold bars for pledging the same doesn’t attract too much attention. ^[17] The Indian masses realized the enormity of the financial crisis only when word spread that gold is taken away for pledging. For a traditional Indian family, the pledging or selling of household gold is an ominous sign of financial distress. Unsurprisingly, the 1991 incident shocked the nation enough to result in economic reforms that transformed the economy. In recent years, gold loan business have evolved with listed companies vying for market share in the lucrative business. Loans against gold jewelry or the selling of gold are still considered a sign that a particular household is facing financial troubles. Loans against gold jewelry rose a shocking 56.2 percent as per data of October 2024 as against just 13.1 percent a year ago. ^[18]It is worth pondering whether such a massive surge in loans against a sensitive asset class like gold is a temporary event or indicative of long-term fundamental weakness. These statistics along with the fact that gold pledging is considered a last-resort alternative signal that there might be a distinct possibility of slowing down.

While gold is an asset-class reassuring stability and emotional attachment, a car is an asset that signals luxury. Car sales have been rising over the past few years in tandem with a growing economy. In October this year, the economy recorded the highest-ever sales due to the festival season. However, the 14 percent year-on-year decline was below the market expectations in November. The two-wheeler sales too were below market expectations even though clocking an impressive increase of 16 percent. ^[19] While the loan against gold data may instill a sense of jitters among the bulls, the car sales raise hope that the fundamental strength of economy is intact as evident in the wedding season. A skeptic may however, add that wedding seasons are typically once-in-a-lifetime events for families where individuals tend to splurge from their lifetime savings and hence may not be indicative of the real state of the economy.

Trump and Tariffs

Export-oriented sectors are the direct beneficiaries of a weak Indian rupee. When local currency is at all-time low, the Indian firms profit as their exported products are denominated in US dollars. Firms obtain foreign exchange fluctuation gains while translating the sales proceeds to Indian currency. This current advantage of Indian companies is under threat after Donald Trump takes office and acts on his tariff promise. On 12th October 2024, Trump singled out India as the “biggest import tariff charger” and vowed to introduce reciprocal tax if elected to power. ^[20] In November, the US election results showed that American voters favoured the return of Trump. The President-elect has recently threatened 100% tariffs on the BRICS nations. ^[21]

In a recent social media post, Trump excluded India from the initial tariff plans choosing to focus on China, Mexico, and Canada. ^[22] While India may breathe a sigh of relief with this reprieve, Indian exporters will surely face a tariff war situation at the global level as early as next quarter. The resulting hike in retail prices of their product will result in lower demand. US was the largest export destination for Indian exports last year accounting for a 17 percent share. ^[23] Compared to a total of $ 436.48 billion in exports in the first half of the previous accounting year, this year's exports were at $ 468.27 billion. ^[24] If the tariff war intensifies after the USA & China spar, it will lead to uncertainty and damage the Indian GDP figures too. China has already fired the first salvo at the US by banning exports of certain rare minerals. ^[25] Trump will surely snipe at China in an aggressive response once he assumes office after oath-ceremony in January. If the tariff war remains restricted to US & China, Indian exporters stand to gain. However, history suggests that tariff wars are a classic Cold War tactic that usually escalates and snowballs into all-out wars. When inflation in India is uncomfortably high and GDP projections are revised downwards amid a weakening currency, the last thing Indian economy needs is a global tariff war. Regrettably, that’s precisely what the Indian policy makers should expect.

Urban and Rural

For much of the past decade, urban India has been the growth driver of GDP. Starting from metro cities, FMCG companies and luxury car makers observed as the baton shifted to Tier-II and Tier-III cities. The rural areas at best played second fiddle or sometimes played spoilsport when the farm sector suffered losses. When monsoons are satisfactory and agricultural produce is ample, rural India often aids GDP. In the upcoming years, the Indian economy is set to witness the next phase where rural demand will outpace urban centers. When Indian GDP touched a seven-quarter low in Q2, the private consumption in the rural areas stood out with a seven-quarter high of 7.4 percent. Better weather conditions and higher crop sowing supported farm incomes. Morgan Stanley estimates rural demand outpacing urban consumption in the near term. ^[26] Urban India is tightening its purse coming to terms with higher inflation led by vegetable inflation rising over 42.2 percent, a 57-month high. ^[27] Disposable incomes in urban households took a hit and slowed spending over the past 4-5 months. As several agencies reduced the growth forecasts for FY25 following the surprise Q2 GDP, a contrarian stance was taken by S&P. Sticking to its forecast of 6.8 percent for the current fiscal, S&P Global ratings in its India Outlook lowered the FY26 & FY27 projections by only 20 basis points. ^[28] It predicted resilience in urban consumption and seems firmly on the camp of bulls who believe that Q2 was a temporary blip that shall not be repeated.

With geo-political risk looming in the horizon and domestic inflation rising amid a weak currency, the central bank have multiple priorities to balance before its next decision on rate cuts. The government can’t be expected to fuel the growth by compromising on its fiscal deficit targets. Private investments and consumption are the principal means through which sustainable GDP growth needs to be achieved. Whether it will be achieved on its own or if heavy government spending and proactive central bank initiatives will be required will be recognized only after a few more quarters. Is the recent economic blip temporary? Hopefully, it is.

References

^[1] https://www.mospi.gov.in/sites/default/files/press_release/NAD_PR_29112024.pdf
^[2] https://www.cnbc.com/2024/12/06/india-keeps-interest-rate-unchanged-amid-rising-inflation-risks-and-a-slowing-economy-.html
^[3] https://www.thehindu.com/opinion/editorial/%E2%80%8Bstaying-the-course-on-the-rbi-and-inflation/article68955818.ece
^[4] https://www.thehindu.com/opinion/editorial/%E2%80%8Bstaying-the-course-on-the-rbi-and-inflation/article68955818.ece
^[5] https://www.thehindu.com/business/Economy/rbi-raises-inflation-outlook-to-48-for-fy25/article68953928.ece
^[6] India: Is the world's fastest-growing big economy losing steam?
^[7] https://www.business-standard.com/economy/news/govt-capital-expenditure-drags-down-growth-in-investment-shows-nso-data-124112901094_1.html
^[8] https://economictimes.indiatimes.com/news/economy/indicators/india-gdp-q2-fy25-growth-data-analysis-and-economic-key-highlights/articleshow/115804907.cms?from=mdr
^[9] https://economictimes.indiatimes.com/news/economy/indicators/india-gdp-q2-fy25-growth-data-analysis-and-economic-key-highlights/articleshow/115804907.cms?from=mdr
^[10] https://www.thehindu.com/business/Economy/new-investments-see-a-boom-in-second-quarter/article68803863.ece
^[11] https://economictimes.indiatimes.com/markets/stocks/news/indias-q2-fy25-gdp-a-bump-in-the-road-or-a-sign-of-resilience/articleshow/115886516.cms?from=mdr
^[12] https://www.timesnownews.com/business-economy/economy/rupee-falls-to-record-low-settles-at-84-84-against-us-dollar-why-inr-is-sliding-article-116213820
^[13] https://www.business-standard.com/finance/news/rupee-stumbles-1-paisa-to-all-time-low-of-84-40-against-us-dollar-124111400320_1.html
^[14] https://finimize.com/content/indian-rupee-hits-record-low-against-rising-us-dollar
^[15] https://economictimes.indiatimes.com/news/economy/policy/indias-economic-slowdown-which-way-are-the-gears-shifting/articleshow/115896477.cms?from=mdr
^[16] https://economictimes.indiatimes.com/news/economy/policy/indias-economic-slowdown-which-way-are-the-gears-shifting/articleshow/115896477.cms?from=mdr
^[17] https://theprint.in/pageturner/excerpt/how-chandra-shekhar-govt-and-rbi-hatched-a-plan-to-lease-out-indias-gold-in-1991/1236610/
^[18] https://www.deccanherald.com/opinion/india-is-sacrificing-growth-it-needs-to-stop-3312758
^[19] https://www.business-standard.com/industry/auto/car-sales-drop-by-14-in-november-2-wheelers-see-16-jump-fada-124120900194_1.html
^[20] https://www.thehindu.com/news/international/trump-says-india-biggest-import-tariff-charger-vows-to-reciprocate-if-elected/article68745043.ece
^[21] https://m.economictimes.com/news/economy/foreign-trade/donald-trumps-100-brics-tariff-threats-how-india-could-be-affected-in-a-renewed-trade-war/articleshow/115858556.cms
^[22] https://indianexpress.com/article/business/donald-trump-tarrif-india-exclude-china-mexico-canda-9690534/
^[23] https://www.statista.com/statistics/650654/export-share-by-destination-country-india/
^[24] https://pib.gov.in/PressReleasePage.aspx?PRID=2073286
^[25] https://m.economictimes.com/news/international/global-trends/why-chinas-ban-on-exports-of-rare-minerals-gallium-germanium-could-cost-us-billions/articleshow/116048772.cms
^[26] https://www.cnbctv18.com/economy/morgan-stanley-upgrades-india-fy25-gdp-forecast-rural-vs-urban-consumption-19473149.htm
^[27] https://www.indiatoday.in/magazine/economy/story/20241216-india-gets-a-growth-shock-i-india-gdp-growth-2646398-2024-12-07
^[28] https://www.business-standard.com/economy/news/india-set-for-resilient-growth-in-2025-driven-by-urban-consumption-s-p-124121000776_1.html

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