What’s the news?

• The growing chasm between wages or salaries and the cost of living has given rise to a distressing scenario: the affordability of vital food commodities is under threat.

Central idea

• In Mumbai, the cost of a vegetarian thali surged 65% in five years, while income for laborers and salaried workers in urban Maharashtra increased only 37% and 28%, respectively. This discrepancy is making essential food items unaffordable, leading to compromised meals.

What is Thalinomics?

• Thalinomics is a term coined by an Indian economist and former Chief Economic Adviser to the Government of India, Arvind Subramanian.
• It refers to a concept that involves analyzing changes in the cost of a vegetarian thali (a meal consisting of a variety of dishes served on a single plate) to gain insights into the trends and dynamics of food inflation and affordability.
• It involves tracking the prices of key ingredients that constitute a thali, such as cereals, pulses, vegetables, and other essential items.
• This concept is particularly relevant in countries like India, where food affordability and inflation are significant concerns for a large population.

Key insights: A case study of Mumbai and urban Maharashtra

• Rising Cost of Thali: The cost of preparing a home-cooked vegetarian thali in Mumbai has increased significantly by 65% over the past five years. This increase is attributed to rising prices of essential ingredients like rice, dal, vegetables, and other items that constitute a thali.
• Income Growth: Over the same five-year period, the average wage earned by casual laborers in urban Maharashtra increased by 37%, while the average salary of regular salaried workers increased by 28%. These income growth rates reflect the changes in earnings for these two categories of workers.
• Disparity Between Costs and Income: While the cost of a thali increased by 65%, income growth for casual laborers and salaried workers was significantly lower, at 37% and 28%, respectively.
• Affordability Challenge: The disparity between rising costs and income growth has resulted in essential food items becoming increasingly unaffordable for households. This affordability challenge can lead to reduced portion sizes or a compromise in the variety and nutritional quality of meals.
• Impact on Budget Share: The study also analyzes the portion of monthly wages or salaries required to afford two thalis every day for a month. This share increased from 22.5% of a casual laborer’s monthly earnings in 2018 to 27.2% in 2023. For salaried employees, it increased from 9.9% to 12.8% over the same period.

• Incomplete Data: Data limitations, particularly regarding the absence of certain ingredients like spices and ghee in the analysis, This suggests that the actual cost of making a thali could be even higher than the calculated figures.

Key aspects of the relationship between thali prices and inflation

• Inflation and Ingredient Prices: The prices of ingredients like rice, dal, vegetables, and oil can be affected by inflation. If the prices of these essential ingredients rise due to inflationary pressures, the overall cost of preparing a thali would increase.
• Food Inflation: The cost of a thali, which is composed of various food items, is directly influenced by food inflation. If there’s high food inflation, it can significantly impact the affordability of thalis and other meals.
• Supply and Demand Dynamics: Inflation can be driven by supply and demand imbalances. If there’s a shortage of certain ingredients due to supply disruptions (e.g., poor harvests or transportation issues), prices can rise. Similarly, changes in consumer demand patterns can affect the prices of specific ingredients, further impacting thali costs.
• Monetary Policy: Central banks often use monetary policy tools to control inflation. Interest rate adjustments, money supply regulation, and other measures can impact inflation rates. High inflation rates can lead to increased production costs for farmers and manufacturers, which may trickle down to the prices of thali ingredients.
• Income Effects: Inflation can impact consumers’ purchasing power. When inflation outpaces income growth, households might need to allocate a larger portion of their income to cover basic expenses like food. This can particularly affect lower-income households, leading to affordability challenges for items like thalis.
• Regional Variation: Inflation rates can vary regionally and even locally. Different regions might experience different rates of inflation due to factors like supply chain disruptions, local economic conditions, and government policies.
• Government Policies: Government policies such as subsidies, import/export regulations, and agricultural policies can influence ingredient prices and, consequently, the cost of preparing a thali. These policies can impact the supply and availability of key ingredients.

Implications of the higher cost of a thali

• Nutritional Impact: The rising cost of thali ingredients can lead to compromised nutritional intake as households might cut back on certain items to manage expenses. This can result in inadequate diets and potential health implications.
• Affordability Strain: As thali prices escalate, households may face financial strain by allocating a larger portion of their income to food expenses. This can limit their ability to save, invest, and engage in non-essential expenditures.
• Dietary Diversity: Increased thali costs can potentially lead to reduced dietary diversity as households might opt for cheaper, less nutritious alternatives, affecting overall dietary quality.
• Balanced Meals: Higher thali costs might lead to smaller portions or fewer items in the thali, disrupting the balance of a typical meal and potentially impacting satiety and nutritional completeness.
• Quality of Life: Reduced dietary quality due to affordability challenges can have broader implications for individuals’ quality of life, health, and overall well-being.
• Economic Struggles: For households with limited disposable income, the burden of increased thali costs can exacerbate economic struggles and hinder progress.

Way forward

• Policy Interventions: Implement policies to address the widening gap between thali costs and income growth, ensuring that essential food remains affordable.
• Income Enhancement: Focus on raising wages for casual laborers and salaried workers to match the rising cost of thalis.
• Affordability Measures: Establish measures to mitigate the impact of expensive thalis on households, considering subsidies or targeted assistance.
• Nutrition Awareness: Launch campaigns to educate households about maintaining nutritious diets even when faced with affordability challenges.
• Gender-Inclusive Approach: Address gender disparities by formulating policies that empower women economically.
• Data-Driven Approach: Base policies on accurate and up-to-date data on food prices, wages, and consumption patterns.
• Food Security Initiatives: Strengthen food security programs to ensure access to nutritious food despite thali cost increases.
• Policy Evaluation: Continuously assess the effectiveness of policies in addressing thali affordability and overall well-being.

Conclusion

• The shifting dynamics between escalating costs and relatively stagnant income pose a serious challenge to maintaining a nutritionally balanced diet. As prices continue to rise, a more comprehensive approach is crucial to ensuring that affordable nutrition remains within reach for all strata of society.

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Central idea

• In recent weeks, a notable surge in vegetable prices has acted as a harbinger of a potential increase in overall inflation, as gauged by the consumer price index. This inflationary trend, if sustained, could breach the upper threshold of the Reserve Bank of India’s (RBI) targeted inflation framework.

Inflation Trend Analysis

• Initial Indications of Upward Movement: The recent surge in vegetable prices over the past few weeks served as an early signal of an impending inflationary trend. These signs prompted expectations of an escalation in overall inflation, as gauged by the consumer price index, during the months of July and August.
• Confirmed by Official Data Release: The National Statistical Office’s data release on Monday solidified these apprehensions. Headline retail inflation surged to a 15-month high of 7.44 per cent in July, marking a substantial increase from the 4.87 per cent recorded in June.
• Food Prices as the Main Catalyst: Dissecting the data, it becomes evident that the major driving force behind this surge has been the elevated food prices. The consumer food price index soared to 11.51 per cent in July, significantly up from the 4.55 per cent reported the previous month.

• Core Inflation and Goods/Services Inflation Trends:
  • Core Inflation: Excluding the volatile food and fuel components, core inflation has shown a moderation trend, as noted by ICRA.
  • Goods and Services Inflation: Both goods (excluding food) and services inflation have demonstrated a softening trend, indicating a certain degree of stability.

Food Categories and Their Impact

• Vegetables: This category experienced a staggering price rise of 37.3 per cent, serving as a primary contributor to the overall increase.
• Spices: Prices of spices surged by 21.6 per cent, further accentuating the inflationary pressure within the food segment.
• Pulses and Products: With an inflation rate of 13.2 per cent, pulses and related products added to the upward trend in food prices.
• Cereals and Products: A rise of 13 per cent in this category also contributed to the overall surge in food inflation.

Central Bank’s Perspective

• Early Warnings Heeded: Recognizing the potential implications for overall inflation, the Reserve Bank of India (RBI) took swift action during its recent monetary policy committee meeting.
• Proactive Forecast Revision: In a preemptive move, the RBI adjusted its inflation projection for the second quarter upwards. The initial estimate of 5.2 per cent was revised to 6.2 per cent, reflecting the central bank’s readiness to address the imminent inflationary pressure.
• Confirmation through Data: The RBI’s perspective received validation with the release of official data by the National Statistical Office. The subsequent surge in headline retail inflation to a 15-month high of 7.44 per cent in July, from the previous month’s 4.87 per cent, bolstered the central bank’s concerns.
• Food as a Key Driver: The central bank’s analysis correctly identified that the main driver behind this inflationary surge was the escalating food prices. The consumer food price index’s significant rise to 11.51 per cent in July, compared to 4.55 per cent in the previous month, reinforced the central bank’s focus on this critical aspect.

Impact of the inflation trends

• Consumer Affordability: The surge in vegetable prices contributes to overall inflation, impacting consumers’ ability to afford essential goods. As prices rise, individuals might need to allocate more of their budget to food, potentially reducing spending on other items.
• Budgetary Strain: Higher food prices, particularly vegetables, strain household budgets, affecting families’ purchasing power. This burden is often more pronounced for lower-income households, potentially leading to trade-offs in spending and impacting overall consumption patterns.
• Cost-Push Inflation: The rise in food prices, driven by vegetables and other factors, can lead to cost-push inflation. This occurs when higher production costs are passed on to consumers, causing a general increase in the price level across various sectors.
• Wage Pressure: Elevated inflation can lead to demands for higher wages by workers to maintain their real income levels. Businesses might face challenges managing increased labor costs, potentially affecting profitability.
• Monetary Policy Adjustment: The Reserve Bank of India (RBI) might need to consider adjusting its monetary policy to address the rising inflation. This could involve raising interest rates to control demand and curb price increases, potentially impacting borrowing costs and investments.

Conclusion

• Despite optimism about a forthcoming correction in vegetable prices, the economy remains vulnerable to external shocks such as crude oil price fluctuations. The committee’s continued vigilance and strategic policy responses will be pivotal in managing inflationary pressures and maintaining economic stability.

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What’s the news?

• The Indian economy grapples with a soaring fiscal deficit and public debt, posing a critical challenge to its financial stability. With impending state and general elections in 2023 and 2024, the electoral budget cycle could worsen the debt situation, raising questions about its sustainability.

Central idea

• The escalating levels of fiscal deficit and public debt in India have been a persistent concern, even before the COVID-19 pandemic hit. Although there has been some recovery in the post-pandemic period, projections indicate that returning to pre-pandemic debt levels in the medium term seems unlikely.

What is meant by fiscal deficit?

• A fiscal deficit refers to the difference between a government’s total expenditures and its total revenues (excluding borrowings) during a specific period, usually a fiscal year.
• It is a crucial component of a country’s fiscal policy and represents the amount of money the government needs to borrow to meet its expenditure commitments when its total expenses exceed its total revenue.

What is meant by public debt?

• Public debt represents the total amount of money that a country’s central government owes to various creditors, whether individuals, financial institutions, or foreign governments, at a specific point in time.
• It is the cumulative result of past fiscal deficits and surpluses. Public debt includes all outstanding government borrowings, including both short-term and long-term debt.

What is meant by financial repression?

• Financial repression is an economic term used to describe government policies and regulations that manipulate interest rates, capital flows, and other financial instruments to channel funds towards the government’s debt obligations and other strategic priorities.
• It typically involves measures aimed at reducing the cost of government borrowing and raising funds for public spending, often at the expense of savers and investors.

India’s fiscal deficit and public debt

• One of the Highest Debt Levels: Even before the COVID-19 pandemic, debt levels were among the highest in the developing world and emerging market economies.
• Fiscal Deficit: The fiscal deficit in 2020–21 increased to 13.3% of GDP and has receded to 8.9% in the post-pandemic period.
• Public Debt: The aggregate public debt relative to GDP was 89.6% in 2020–21 and decreased to 85.7% after the economy started recovering from the pandemic.
• Debt-to-GSDP Ratios in Specific States: The debt-to-GSDP ratios in specific states: Punjab (48.9%), West Bengal (37.6%), Rajasthan (35.4%), and Kerala (close to 33%)

Impact of financial repression

• High Debt and Interest Payments:
• Financial repression may lead to higher government debt levels as it facilitates borrowing at low-interest rates. As a result, interest payments on the accumulated debt can become a significant burden on the government’s finances.
• On average, interest payments constitute over 5% of GDP and 25% of revenue receipts in India. This surpasses government expenditures on critical sectors like education and healthcare, hindering investments in essential infrastructure and human development.
• State-Specific Concerns: Certain states in India, such as Punjab, Kerala, Rajasthan, and West Bengal, are particularly affected by high Debt-to-GSDP ratios. The debt burden in these states poses challenges for managing finances and implementing developmental initiatives.
• Constraints on Fiscal Policy: Elevated debt levels resulting from financial repression can limit the government’s ability to implement counter-cyclical fiscal policies during economic downturns. This constraint can hinder the government’s capacity to respond effectively to shocks and economic challenges.
• Distorted Financial Market: Government interventions, such as the SLR requirement, can create imbalances in the allocation of funds, affecting the availability of credit for productive sectors like manufacturing.
• Impact on Sovereign Rating and External Borrowing: Persistently high deficits and debt levels can lead to lower sovereign ratings by rating agencies. A low sovereign rating can increase the cost of external commercial borrowing, making it more expensive for the government to raise funds from international markets.
• Burden on Future Generations: Excessive debt accumulation can lead to intergenerational equity issues, with future citizens having to repay the debt and interest accrued during the period of financial repression.

Way forward: Financial Consolidation

• Fiscal Responsibility and Budget Management (FRBM) Rules: Enforce and strengthen the existing FRBM rules to ensure prudent fiscal management. Adhering to these rules can help control deficits and prevent excessive debt accumulation.
• Targeted Interventions: Implement targeted interventions to reduce the debt burden while addressing critical needs such as education, healthcare, and infrastructure development. For instance, the government can allocate funds specifically to boost primary education and healthcare access in states with high debt burdens, such as Punjab, Kerala, Rajasthan, and West Bengal.
• Infrastructure Investments: Prioritize investments in physical infrastructure, human capital, and green initiatives to enhance economic productivity and foster sustainable development. For example, investing in renewable energy projects can support the green transition while creating employment opportunities.
• Enhance Tax Collection and Compliance: Improve tax administration and compliance to increase government revenue. Utilizing technology for cross-matching of GST and income-tax returns can enhance tax collection efficiency and curb tax evasion.
• Fiscal Reforms at the State Level: Encourage states to adopt responsible fiscal policies and avoid excessive borrowing. For example, the central government can provide incentives to states that adhere to fiscal discipline and implement reforms to improve fiscal health.
• Disinvestment and Efficient Asset Management: Pursue disinvestment and strategic asset management to optimize government resources and reduce the need for excessive borrowing. For instance, the government can consider divesting non-essential government assets and utilizing funds from asset sales efficiently. Instead of pouring money into BSNL, which may be better served by private sector expertise, the government can explore disinvestment options.
• Market-Based Interest Rates: Gradually transition towards market-driven interest rates on government borrowing to ensure a more efficient allocation of capital in the financial market. This can help improve credit availability for the private sector.
• Encourage Private Sector Participation: Promote private sector participation in critical sectors, allowing the government to focus on its core functions. For instance, the government can encourage private investment in infrastructure projects through public-private partnerships (PPPs).
• Focus on Cash Transfers: Consider providing targeted cash transfers instead of subsidies for specific commodities and services. Cash transfers can be more efficient at redistributing resources without causing unintended distortions in relative prices.
• Medium-Term Fiscal Consolidation: Develop and implement a medium-term fiscal consolidation plan to gradually reduce the fiscal deficit and public debt levels sustainably. This plan can include specific targets for debt reduction and deficit control.

Conclusion

• Financial repression’s adverse effects, along with the heavy costs of high deficits and debt, necessitate responsible policy interventions and fiscal consolidation. Emphasizing technological advancements and prudent economic policies will be vital in tackling the debt burden and ensuring long-term fiscal sustainability.

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Central Idea

• In India, the States play a crucial role in revenue mobilization, government expenditure, and borrowing. Understanding their fiscal situation is essential for drawing evidence-based conclusions about the country’s overall fiscal health.

Relevance of the topic

Despite the decrease in fiscal deficits, it remains important to address the challenges associated with fiscal imbalances, including persistence of revenue deficits in many States

Revise key concepts Fiscal deficit, revenue deficit, Debt-to-GDP ratio etc

Fiscal imbalance and its impact on an economy and thereby social welfare.

The fiscal imbalance at present

1. Reduction in Fiscal Deficit:

• There has been a significant reduction in fiscal deficits at both the Union and State levels. The Union’s fiscal deficit decreased from 9.1% of GDP in 2020-21 to 5.9% in 2023-24 (BE).
• The aggregate State fiscal deficit also decreased from 4.1% of GDP in 2020-21 to 3.24% in 2022-23 (RE).
• Major States are expected to achieve a fiscal deficit of 2.9% of GDP in 2023-24 (BE).

2. Revenue Deficit Challenge:

• Despite the reduction in fiscal deficits, there is persistence of revenue deficits in many States.
• Out of the 17 major States analyzed, 13 have a deficit in the revenue account for the fiscal year 2023-24 (BE).
• Seven States, namely Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal, experience fiscal deficits primarily driven by revenue deficits.

3. High Debt-to-GSDP Ratios: Some of the States with revenue deficits also have high debt-to-GSDP ratios. This indicates that these States have accumulated significant levels of debt relative to their Gross State Domestic Product (GSDP).

The Impact of fiscal imbalance on an Economy

• Macroeconomic Instability: Fiscal imbalances, such as high fiscal deficits and revenue deficits, can lead to macroeconomic instability. Large deficits may increase government borrowing, which can put upward pressure on interest rates, crowd out private investment, and potentially lead to inflationary pressures. This instability can hinder economic growth and create uncertainty in the business environment.
• Increased Debt Burden: Persistent fiscal imbalances often result in increased government debt levels. High levels of public debt can have adverse consequences, including increased debt servicing costs, reduced fiscal flexibility, and potential credit rating downgrades. A higher debt burden can also limit the government’s ability to invest in critical areas such as infrastructure, education, and healthcare.
• Reduced Public Investments: Fiscal imbalances may necessitate fiscal consolidation measures, such as expenditure cuts and reduced public investments. This can impact critical areas of public spending, including infrastructure development, social welfare programs, and public services. Reduced investments can hinder long-term economic growth and development.
• Limited Policy Space: Fiscal imbalances can limit the government’s ability to implement countercyclical fiscal policies during economic downturns. A high debt burden or constrained fiscal capacity may prevent the government from effectively using fiscal stimulus measures to boost aggregate demand and support economic recovery.
• Pressure on Social Welfare: Fiscal imbalances may lead to reductions in social welfare programs and public services. Austerity measures implemented to address fiscal imbalances can disproportionately affect vulnerable populations and hinder efforts to address income inequality and social welfare needs.
• Investor Confidence and Credit Ratings: Persistent fiscal imbalances can erode investor confidence and negatively impact the country’s credit ratings. A lower credit rating can increase borrowing costs, discourage foreign investment, and limit access to international capital markets.
• Inter-Generational Equity: Fiscal imbalances, particularly when driven by high levels of public debt, can have inter-generational equity implications. The burden of repaying debt and managing fiscal imbalances may fall on future generations, impacting their ability to invest, save, and achieve sustainable economic growth.

Reducing Revenue deficit: Way forward

• Link Interest-Free Loans to Revenue Deficit Reduction: Implement a mechanism where interest-free loans provided by the Union Government to States are linked to a reduction in revenue deficits. This incentivizes States to prioritize revenue generation and reduce reliance on borrowed funds for revenue expenditure.
• Defined Time Path for Revenue Deficit Reduction: Establish a clear timeline and targets for reducing revenue deficits in States. This includes setting specific goals for revenue deficit reduction and developing a credible fiscal adjustment plan to achieve those targets.
• Performance Incentive Grants: Introduce performance incentive grants to reward States that effectively reduce their revenue deficits. The grants can be designed based on the recommendations of previous Finance Commissions, considering factors such as the extent of deficit reduction, fiscal discipline, and efficient revenue management.
• Fiscal Adjustment and Expenditure Rationalization: Encourage States to undertake fiscal adjustment measures to align revenue and expenditure. This involves conducting a detailed analysis of expenditure patterns, prioritizing essential spending, and identifying areas for rationalization and efficiency gains.
• Strengthen Revenue Mobilization: Enhance efforts to improve revenue mobilization by implementing measures such as broadening the tax base, improving tax administration and compliance, and exploring new revenue sources. This includes ensuring effective collection of Goods and Services Tax (GST) and non-GST revenues.
• Public Financial Management Reforms: Strengthen public financial management systems to enhance transparency, accountability, and efficient utilization of resources. This includes improving budgeting processes, expenditure tracking, and financial reporting mechanisms to monitor and control revenue and expenditure.
• Long-Term Revenue Planning: Develop a comprehensive long-term revenue plan that aligns with the country’s development goals. This involves forecasting revenue trends, identifying potential revenue sources, and implementing policies that support sustainable revenue generation over the long term.
• Capacity Building: Invest in building the capacity of State governments in revenue management, tax administration, and expenditure control. This includes providing training and technical assistance to enhance their skills and capabilities in managing revenue deficits effectively.
• Public Awareness and Participation: Conduct public awareness campaigns to educate citizens about the importance of revenue generation, fiscal discipline, and the impact of revenue deficits on public services. Foster public participation in budgeting processes to promote transparency and accountability.
• Regular Monitoring and Reporting: Establish a robust monitoring and reporting mechanism to track the progress of revenue deficit reduction efforts. Regularly assess and report the performance of States in revenue mobilization and deficit reduction to ensure accountability and facilitate necessary corrective actions.

Prelims mark enhancer

Conclusion

• Effectively managing revenue deficits is crucial for achieving fiscal balance and sustainable economic growth. By adopting a macro view and implementing appropriate measures and incentives, India can consolidate revenue deficits in its States. This would ensure fiscal stability, stimulate State-specific growth, and maintain macroeconomic stability at the national level

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Central Idea

• The Indian economy has reached a milestone, surpassing $3.5 trillion in size, reminiscent of China’s position in 2007. While India shows similarities with China, such as comparable per capita income, the two countries diverge significantly in their growth drivers. This divergence has implications for India’s growth trajectory and its ability to achieve upper middle-income status.

Relevance of the topic

India lags behind China on multiple fronts such as investment ratios, export performance, labor force participation, and manufacturing employment. For instance, Female Labor Force Participation of China is 61% (2022) whereas in India it stands at 24% (2022).

The stark disparities provide valuable insights to analyze and propose strategies for India’s future development in areas like investment promotion, export competitiveness, and inclusive growth.

India’s positive growth

• Economic Size: The Indian economy has recently crossed $3.5 trillion in size, according to Moody’s. This indicates a significant expansion of the economy and reflects positive growth.
• Per Capita Income: India’s per capita income is projected to rise from $2,379 in 2022 to $2,601 in 2023, as estimated by the International Monetary Fund (IMF). This upward trend indicates an improvement in individual income levels and suggests positive growth in the economy.
• Exports: India’s exports of goods and services exceeded $770 billion in 2022-23. This demonstrates the country’s ability to compete in the global market and generate revenue through international trade.
• Investment Momentum: While India’s investment ratio has been lower than China’s, there are signs of activity picking up in certain sectors after a slowdown induced by the twin balance sheet problem. This indicates positive momentum in investment and the potential for future growth.
• Services Sector: India has witnessed a growth in the services sector, particularly in areas such as IT and business process outsourcing (BPO). The expansion of the services sector contributes to economic growth and job creation.
• Increase in Formal Manufacturing: India aims to boost formal manufacturing, which has higher productivity compared to other sectors. The focus on manufacturing can lead to increased employment opportunities and overall economic growth.
• Rise in Female Labor Force Participation: Although India’s female labor force participation rate remains lower than China’s, there have been efforts to increase women’s participation in the workforce. This can contribute to enhanced productivity, economic empowerment, and overall growth

Comparison: India’s economic position with China

The disparities between India and China

• Investment Ratio: China’s investment-to-GDP ratio averaged 40% between 2003 and 2011, while India’s investment ratio during the same period averaged around 33%. This indicates that China had a higher level of investment, which contributed to its rapid economic growth.
• Export Performance: In 2022-23, India’s exports of goods and services surpassed $770 billion, while China’s exports had already crossed $1.2 trillion in 2007. China’s deeper integration with the global economy and higher export volumes indicate a more robust export-driven growth model compared to India.
• Tariff Rates: China experienced a decline in tariff rates, with the simple mean falling from 10.69% in 2003 to 5.32% in 2020. In contrast, India’s tariff rate decreased from 25.63% in 2003 to 8.88% in 2017 but has risen thereafter. China’s lower tariff rates have facilitated its emergence as a global supply chain hub.
• Labor Force Participation: China had a considerably higher labor force participation rate, with almost 73% in 2007, while India’s rate stood at around 50% in 2022. The disparity, primarily driven by female labor force participation, impacts spending capacity and economic growth potential.
• Sectoral Employment: Both countries have similar sectoral distribution, but China experienced a faster decline in agricultural employment compared to India. India’s challenge lies in finding alternative employment opportunities for its declining agricultural workforce, with the construction and service sectors historically providing more jobs than formal manufacturing.

Implications of these disparities for future development of India

• Growth Trajectory: The disparities in investment ratios indicate that India may face challenges in achieving rapid economic growth and reaching its developmental goals without increasing investment levels.
• Export Competitiveness: The disparities in export performance suggest that India needs to enhance its global competitiveness to expand its export base and capitalize on international trade opportunities.
• Job Creation: The disparities in labor force participation rates, particularly the low female participation rate, have implications for employment generation and inclusive growth in India.
• Sectoral Shift: The slower decline in agricultural employment compared to other sectors raises concerns about the need for alternative employment opportunities for the declining agricultural workforce
• Investment Climate: The disparities in investment ratios underscore the importance of creating a favourable investment climate in India to attract domestic and foreign investments necessary for sustained economic growth.

Lessons learned from China

• Emphasis on Investment: China’s high investment-to-GDP ratio played a crucial role in its rapid economic growth. India can benefit from prioritizing investments in infrastructure, industries, and human capital development to drive economic expansion and productivity.
• Export-Led Growth: China’s success in becoming a global manufacturing and exporting powerhouse highlights the importance of export-led growth. India can focus on enhancing its export competitiveness, diversifying export markets, and promoting value-added exports to boost economic growth and job creation.
• Trade Liberalization: China’s gradual reduction of tariffs and its efforts to integrate into global supply chains helped it become a major player in international trade. India can learn from this and work towards reducing trade barriers, improving trade infrastructure, and actively participating in regional and global trade agreements to enhance its integration into the global economy.
• Manufacturing Development: China’s strategic focus on developing its manufacturing sector contributed significantly to its economic growth and job creation. India can prioritize the growth of formal manufacturing, foster a business-friendly environment, and provide targeted support to enhance manufacturing capabilities and competitiveness.
• Infrastructure Development: China’s investments in infrastructure, such as transportation networks, energy systems, and telecommunications, played a vital role in supporting its economic growth. India can invest in modernizing and expanding its infrastructure to create a solid foundation for economic development and attract further investments.
• Human Capital Development: China’s emphasis on education, skills training, and research and development (R&D) has contributed to its technological advancement and innovation capabilities. India can focus on improving the quality of education, enhancing vocational training programs, and promoting research and development to nurture a skilled workforce and foster innovation.
• Long-Term Planning: China’s long-term development plans, such as its Five-Year Plans, provided a roadmap for sustained economic growth and policy continuity. India can develop comprehensive and strategic plans that align with its development goals and ensure consistent implementation of economic policies.
• Infrastructure for Special Economic Zones (SEZs): China’s establishment of SEZs played a pivotal role in attracting foreign direct investment and promoting export-oriented manufacturing. India can learn from this model and develop specialized zones with the necessary infrastructure, incentives, and supportive policies to attract investments and promote targeted sectors.

Conclusion

• In the coming years, India’s growth may continue at a moderate pace, even if low- and semi-skilled job creation in manufacturing falls short. However, achieving the explosive growth witnessed by China between 2007 and 2021 would require increased investment activity, a resurgence in exports (particularly goods), a rise in female labor force participation, and greater employment opportunities in formal manufacturing. India must strive to replicate the success story of its neighbor if it aims to achieve rapid economic advancement.

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Central Idea

• In the pursuit of communal and caste politics, India’s focus on the economy has been overshadowed. However, the growing divide among classes is silently reshaping the Indian electorate, with more than 50% of the population being left behind by economic growth. It is essential to address the economic concerns of all citizens, regardless of caste and religion, and embrace a new paradigm of economics.

The Global Solutions Summit

• Global Solutions Summit, 2023 held at Berlin.
• The theme at the Global Solutions Summit this year, was a new paradigm for the economy.
• Its backdrop was the rising tensions in the east between the United States and China, and the war in the west between the North Atlantic Treaty Organization (NATO) and Russia
• The dominant G-7 countries, representing only 15% of the world’s population, exert undemocratic pressure on other nations, raising concerns about global democracy.
• The think tanks of the G-20 and other countries at the summit called attention to global problems of climate change, increasing economic inequalities within and among countries, and the effects of the financial and trade sanctions imposed by the most powerful nation, which are affecting the other 85% most of all.

Prevalence of Political and economic divisions in societies worldwide

Political Divisions

• Ideological divisions: Political ideologies such as conservatism, liberalism, socialism, and populism can create stark divisions in society, with contrasting views on the role of government, individual rights, and social policies.
• Partisan politics: Political parties and their supporters often exhibit deep divisions, especially during elections and policy debates, based on party affiliations, policy preferences, and competing interests.
• Identity politics: Divisions along the lines of race, ethnicity, religion, gender, and other social identities can shape political landscapes, with groups advocating for their specific interests and rights.
• Regional disparities: Regional differences in economic development, cultural norms, and historical grievances can lead to political divisions, with demands for greater autonomy or regional representation.

Economic Divisions

• Income inequality: The unequal distribution of wealth and income can create divisions between the rich and the poor, with implications for access to resources, opportunities, and social mobility.
• Urban-rural divide: Disparities between urban and rural areas in terms of economic opportunities, infrastructure, and public services can lead to economic divisions and political differences.
• Global economic disparities: The divide between developed and developing countries, as well as within countries, contributes to economic divisions, with implications for trade, investment, and development policies.
• Labour market divisions: Differences in employment opportunities, wages, and working conditions can create divisions between different sectors of the economy, such as skilled and unskilled workers or formal and informal sectors.

Evolution of Economic Systems

• Traditional Economy: In traditional economies, production is based on customs, traditions, and barter systems. It typically revolves around subsistence agriculture, hunting, gathering, and small-scale artisanal activities. This system is prevalent in agrarian and indigenous societies.
• Command Economy: Command economies emerged with the rise of centralized governments and planned economies. The state assumes control over the means of production, distribution, and resource allocation. Central planning and government directives determine economic activities and resource allocation. The Soviet Union under communism is an example of a command economy.
• Market Economy: Market economies are characterized by decentralized decision-making and the interaction of supply and demand forces in determining prices, resource allocation, and production decisions. Private ownership of property, individual freedom, and competition play crucial roles. Free-market capitalism, as advocated by Adam Smith, is a key model of a market economy.
• Mixed Economy: Most modern economies are mixed economies that combine elements of both market and command systems. In a mixed economy, the government intervenes to regulate markets, provide public goods and services, and address market failures. The extent of government intervention varies across countries and can range from social welfare programs to industrial regulations.
• Socialist Economy: Socialist economies emphasize social ownership and collective decision-making in economic activities. The means of production are typically owned by the state or workers’ collectives. The aim is to reduce inequality and ensure equitable distribution of resources. Examples include the former Soviet Union and China under Mao Zedong.
• Market Socialism: Market socialism blends elements of market economies with socialist principles. It allows for private ownership and market mechanisms but aims to maintain social equity through state intervention, wealth redistribution, and public ownership of key industries. Some Scandinavian countries, such as Sweden and Norway, incorporate aspects of market socialism.
• Post-Industrial Economy: The post-industrial economy is characterized by a shift from manufacturing and heavy industry to service-based industries, information technology, and knowledge-based sectors. It is driven by innovation, technological advancements, and the growing importance of intellectual capital.

Need to reform the GDP-centric model

• Inadequate Measure of Well-being: GDP (Gross Domestic Product) measures the monetary value of all final goods and services produced within a country’s borders. However, it fails to capture important aspects of well-being, such as the distribution of wealth, social indicators, environmental sustainability, and quality of life.
• Overemphasis on Economic Growth: The GDP-centric model places excessive focus on economic growth as the primary indicator of success. While economic growth is important, it should not be the sole measure of a nation’s progress.
• Ignoring Income Inequality: GDP growth does not necessarily translate into equitable distribution of wealth and income. It often perpetuates income inequalities, as the benefits of growth may disproportionately accrue to a few privileged individuals or groups.
• Unsustainable Resource Consumption: The GDP-centric model often encourages unsustainable patterns of resource consumption and production. It fails to account for the environmental costs and depletion of natural resources associated with economic activities.
• Neglecting Non-Monetary Factors: The GDP-centric approach overlooks non-monetary factors that contribute to overall well-being, such as health, education, social capital, cultural heritage, and quality of life. These factors are critical for human development and should be considered alongside economic indicators to provide a comprehensive assessment of progress.
• Inaccurate Reflection of Informal Economy: The GDP-centric model struggles to capture the contributions of the informal economy, which often represents a significant portion of economic activity in many countries. Informal sector workers and their economic contributions remain largely unaccounted for in traditional GDP calculations.
• Need for Alternative Metrics: There is a growing need for alternative metrics and indicators that capture a broader range of factors affecting well-being, such as the Human Development Index (HDI), Genuine Progress Indicator (GPI), Sustainable Development Goals (SDGs), and well-being indices. These metrics consider social, environmental, and economic dimensions to provide a more holistic understanding of progress.

Need for a New Economic Paradigm in India

• Rising Inequality: India faces significant income and wealth inequalities, with a large portion of the population left behind by economic growth. The current economic system has failed to adequately address these inequalities and provide equal opportunities for all citizens.
• Unemployment and Job Creation: India has been grappling with high unemployment rates and a lack of sufficient job opportunities, especially for its burgeoning youth population. The existing economic model needs to be reimagined to prioritize job creation, skill development, and entrepreneurship to harness the demographic dividend effectively.
• Sustainable Development: Environmental degradation, climate change, and resource depletion are pressing challenges for India. A new economic paradigm should prioritize sustainability and integrate environmental considerations into economic decision-making.
• Social Welfare and Human Development: While economic growth is essential, it must be accompanied by investments in social welfare and human development. Access to quality education, healthcare, housing, and social security are critical for the well-being of citizens. A new economic paradigm should prioritize human development indicators alongside economic indicators to ensure the holistic development of the population.
• Agricultural Distress: India’s agricultural sector faces various challenges, including farmer distress, low productivity, and lack of market access. The new economic paradigm should address these issues by promoting sustainable agriculture, improving rural infrastructure, enhancing farmers’ income, and ensuring food security.
• Digital Transformation and Innovation: India is experiencing a digital revolution, with rapid technological advancements and a growing digital economy. The new economic paradigm should leverage the potential of digital transformation and innovation to drive inclusive growth, improve governance, and enhance competitiveness in the global economy.
• Governance and Transparency: Enhancing governance, promoting transparency, and curbing corruption are essential for sustainable economic development.

Conclusion

• India urgently needs a new economic paradigm that addresses the concerns of its citizens. The focus should shift towards inclusivity and social justice, rather than perpetuating economic inequalities. Reforms must prioritize the well-being of all, and economists should revaluate their current models to create a more equitable and sustainable future for India.

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Central Idea

• India’s recent decline in consumer price index (CPI) inflation and food price inflation has brought a degree of comfort to the Reserve Bank of India (RBI). However, the challenge lies in managing inflation while aiming for a GDP growth of 6 to 6.5 percent in FY24. Collaborative efforts between the RBI and the Government of India are crucial to achieving this twin objective.

Current Inflation Scenario

• The CPI inflation for April 2023 stood at 4.7 percent, with food price inflation even lower at 3.84 percent.
• Maintaining overall inflation below 5 percent and GDP growth above 6 percent throughout the year would be a commendable achievement.

Importance of Managing Food Inflation

• Managing food inflation is crucial due to its significant weightage in the consumer price index (CPI) basket in India. The food and beverages component holds the highest weightage of 45.86% among G20 countries.
• Food inflation directly impacts the cost of living for the general population, particularly vulnerable sections that spend a significant portion of their income on food.
• High food inflation can lead to increased household expenses, lower purchasing power, and a decline in the overall standard of living.
• Food inflation can also have social and political implications, as rising food prices can cause public unrest and dissatisfaction.
• Effective management of food inflation contributes to maintaining price stability, ensuring food affordability, and supporting macroeconomic stability.

Implications of Monsoon Season

• Agricultural Production: The monsoon is crucial for agricultural production as it provides the majority of the water needed for irrigation. A normal or above-normal monsoon season supports adequate water availability, leading to higher crop yields and increased agricultural output. Conversely, a below-normal monsoon can lead to drought-like conditions, affecting crop productivity and agricultural incomes.
• Food Prices: The monsoon significantly influences food production, particularly for rain-fed crops. Insufficient rainfall can lead to lower agricultural output, resulting in reduced supplies and higher food prices. Inadequate monsoon rains can impact staple crops such as rice, wheat, pulses, and oilseeds, leading to inflationary pressures on food prices.
• Rural Economy: As agriculture plays a vital role in the rural economy, the monsoon directly impacts rural livelihoods and income levels. A good monsoon season can boost rural incomes, increase agricultural employment opportunities, and stimulate rural consumption. Conversely, a poor monsoon can lead to income losses, lower agricultural wages, and reduced rural demand.
• Hydroelectric Power Generation: The monsoon contributes to water reservoirs, which are essential for hydroelectric power generation. Adequate rainfall ensures sufficient water levels in reservoirs, supporting electricity generation from hydroelectric plants. Inadequate monsoon rains can result in lower water levels, impacting power generation and potentially leading to electricity shortages.
• Groundwater Recharge: The monsoon plays a crucial role in replenishing groundwater levels. Adequate rainfall helps recharge aquifers, which are vital sources of water for irrigation, drinking water, and industrial use. Insufficient monsoon rains can lead to depleted groundwater levels, affecting agriculture, water availability, and overall water security.
• Economic Growth: The performance of the agricultural sector, influenced by the monsoon, has implications for overall economic growth. Agriculture contributes significantly to India’s GDP and employment. A good monsoon season can stimulate rural demand, enhance agricultural productivity, and contribute to higher economic growth. Conversely, a poor monsoon can dampen agricultural output, impacting overall economic performance.
• Fiscal Impact: The monsoon season also has implications for government finances. Adequate rainfall supports agricultural production and reduces the need for government interventions such as subsidies or price support measures. In contrast, a poor monsoon can strain government resources, necessitating increased spending on irrigation infrastructure, relief measures, or support to affected farmers.

What are the challenges in milk inflation?

• Supply-side Factors: Milk inflation is influenced by supply-side dynamics. Factors such as adverse weather conditions, including drought or floods, can impact the availability of fodder and water for cattle, leading to reduced milk production. Any disruptions in the supply chain, such as transportation issues or logistical challenges, can also affect the supply of milk and contribute to inflationary pressures.
• Disease Outbreaks: Disease outbreaks among cattle, such as lumpy skin disease, foot-and-mouth disease, or other health issues, can affect milk production. These outbreaks may result in a decrease in the number of healthy and productive cattle, leading to a decline in milk output and subsequently driving up milk prices.
• Fodder Prices: The cost of animal feed, such as fodder, plays a significant role in milk production costs. Fluctuations in fodder prices can impact the overall cost of maintaining dairy cattle. If fodder prices increase due to factors like supply-demand imbalances, weather conditions, or changes in agricultural practices, it can contribute to higher milk prices.
• Input Costs: Various input costs involved in milk production, such as labor, veterinary services, and energy costs, can affect the overall cost structure. Increases in input costs, including wages, veterinary medicines, or energy prices, can exert upward pressure on milk prices.
• Import Dependence: In some cases, countries may rely on milk imports to meet domestic demand. If the import costs increase due to factors like changes in international prices, trade policies, or exchange rate fluctuations, it can contribute to higher domestic milk prices.
• Market Structure and Competition: The market structure and competition within the dairy industry can impact milk prices. If the market is concentrated with a limited number of dominant players, it may lead to less competition, allowing suppliers to exercise greater pricing power. This can contribute to higher milk prices for consumers.
• Government Policies and Regulations: Government policies and regulations related to milk production, procurement, and pricing can influence milk inflation. Policies such as subsidies, import restrictions, quality standards, or pricing mechanisms can affect the overall supply-demand dynamics and pricing in the milk market

Way ahead

• Focus on buffer stocking policy: To tackle cereal inflation, using the buffer stocking policy more proactively is important. Unloading excess stocks in open market operations can be an effective tool in managing cereal inflation.
• Preemptive policy actions: It is important to implement policy actions in a preemptive manner rather than being reactive to events. This includes timely unloading of excess stocks and adjusting import duties to maintain price stability.
• Monitor and address external shocks: Given that food price inflation can be triggered by external shocks like droughts and supply chain disruptions, it is crucial to closely monitor such factors and take appropriate measures to mitigate their impact.
• Strengthen milk production: To address milk inflation, efforts should be made to address factors like the lumpy skin disease and high fodder prices that have strained milk production. Policies supporting the growth and sustainability of the milk industry should be implemented.
• Lower import duties on fat and skimmed milk powder (SMP): By reducing import duties to around 10 to 15 percent, there could be an increase in imports of fat and SMP, which may help in controlling milk and milk product prices.

Conclusion

• By effectively managing inflation, implementing proactive policies, and fostering collaboration between the RBI and the Government of India, India can navigate the challenges of inflation management, ensure economic stability, and promote sustainable development in critical sectors.

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Central Idea

• The Indian economy is in a state of ambiguity, with different viewpoints and statistics painting a fuzzy picture. While some argue that India is well-positioned to be an economic superpower, the true picture is not that straightforward.

An assessment of the Indian economy based on various factors

1. Inflation:

• According to the MPC meeting minutes, inflation is under control, but households are witnessing an increase in the prices of goods and services.
• While the base effect will bring down the inflation numbers, households still complain of having a cumulative inflation of over 18 per cent in the last three years.

2. Growth:

• The growth picture is ambivalent, with the new normal appearing to be 6-7 per cent.
• While some argue that India is the fastest-growing economy, this is only true if smaller nations are excluded.
• There is not too much optimism about being on track for the 8 per cent-plus growth rate, which we were used to earlier.

3. Exports: While there has been satisfaction expressed by the new heights achieved in the exports of goods and services, exports of merchandise are not too satisfactory. For example, if refinery products are excluded from the export’s basket, there has been a fall in FY23.
4. Investment:

• The official position is that investment is picking up in the private sector, but data on all funding sources show that there is a slowdown.
• Bank credit is buoyant more on the retail end than manufacturing. Debt issuances are dominated by the financial sector with manufacturing lagging.
• External Commercial Borrowings (ECBs) have slowed down mainly due to the higher cost of loans.

5. Consumption: The consumption picture is also fuzzy, with nominal consumption growing by 16 per cent in FY23, but this is pushed up by inflation, and pent-up demand for both goods and services post the full removal of the lockdown in 2022.
6. Employment:

• The average unemployment rate is around 7.5 per cent, but the concern is more on the labour participation rate, which has been coming down. This indicates a growing population in the working age group that is not interested in working.
• Start-ups have not yet been job creators to the degree that was expected, given the push by the government over the years.

7. Banking sector: The banking sector has emerged stronger with lower NPA levels and improved profitability, which implies that as and when the economy gets into the take-off mode, banks will be well-equipped to provide the funds.

Facts for prelims: Basics

 What are the concerns?

• Employment Generation: The decline in the labor force participation rate and layoffs in certain sectors raise significant challenges in terms of job creation and reducing unemployment levels.
• Manufacturing Competitiveness: The decline in merchandise exports (excluding refinery products) indicates potential hurdles in enhancing the competitiveness of the manufacturing sector and expanding exports.
• Execution of Investment Intentions: The gap between investment intentions and actual investments is a concern as it indicates potential bottlenecks or challenges in translating investment plans into action.
• Consumption Growth and Affordability: Affordability issues due to inflation impacting real consumption growth raise concerns about sustained consumer demand.
• Export Diversification: The dependence on a few economies for exports and the potential impact of a global economic slowdown on Indian exports are concerns. Diversifying export destinations and exploring new markets can help reduce vulnerability to global economic fluctuations and strengthen export resilience.
• Effective Implementation of Banking Sector Reforms: While improvements have been observed in the banking sector, concerns about funding sources and the need for increased credit flow to the manufacturing sector indicate ongoing challenges.

Way ahead

• Focus on inflation control: While the MPC has managed to keep inflation under control from a policy perspective, efforts should continue to address the impact of rising prices on households. Measures to enhance supply chain efficiency, promote competition, and reduce production costs can help alleviate inflationary pressures.
• Promote sustainable and inclusive growth: While the current growth rate is positive, efforts should be made to achieve higher and more inclusive growth. This can be done by investing in infrastructure development, skill development programs, and initiatives that support the growth of MSMEs (Micro, Small, and Medium Enterprises).
• Boost exports: Enhancing the competitiveness of Indian goods and services in global markets is crucial for a robust export sector. Continued efforts to improve the ease of doing business, implement the Production-Linked Incentive (PLI) scheme effectively, and diversify export destinations can help boost exports.
• Facilitate investment: Policy measures should focus on encouraging private sector investment and reducing funding bottlenecks. This can involve improving the ease of doing business, simplifying regulatory processes, and providing incentives for both domestic and foreign investments.
• Strengthen consumer demand: Initiatives to support consumer demand can include income support programs, targeted subsidies, and measures to enhance consumer confidence. Reducing the impact of inflation on household budgets and boosting purchasing power can help drive consumption growth.
• Address unemployment and labor force participation: Policies aimed at promoting skill development, entrepreneurship, and job creation can help address unemployment concerns. Encouraging sectors with higher labor-intensive potential, such as manufacturing and services, and supporting start-ups and MSMEs can be vital in generating employment opportunities.
• Continue banking sector reforms: While the banking sector has made progress in reducing NPAs and improving profitability, ongoing reforms should be sustained to strengthen the sector further. Maintaining prudent lending practices, enhancing risk management frameworks, and promoting transparency and governance will be essential.
• Foster domestic innovation and technology adoption: Encouraging innovation, research and development, and technology adoption can boost productivity and competitiveness across sectors. This can be achieved through policies that promote collaboration between industry and academia, provide incentives for innovation, and invest in digital infrastructure.
• Maintain macroeconomic stability: Ensuring fiscal discipline, sound monetary policy, and a stable regulatory environment will be crucial for sustaining macroeconomic stability. This can help maintain investor confidence and provide a conducive environment for economic growth.

Conclusion

• The Indian economy’s broad numbers look statistically realistic, but the triad of employment, consumption, and private investment has to bear fruit. Domestic initiatives have to drive the story forward, as the world economy slows down.

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Central Idea

• India has had an established track record of high growth, with an average annual GDP growth of 6.6% in the decade leading up to the Covid-19 pandemic. In fiscal 2023, India is seen growing at 7%, making it the fastest-growing large economy. But with an imminent global slowdown and the full manifestation of the lagged impact of interest rate hikes since May 2022, the economy is expected to decelerate and grow at 6% in fiscal 2024.

Indian economic growth prospects

• Growth accounting: Growth accounting provides a useful framework to analyse medium-term prospects by decomposing their drivers into the contribution of capital, labour and efficiency.
• Economic growth next five years: Indian economy expected to grow at 6.8 per cent per year for the next five years with 52 per cent of it from capital, 38 per cent from efficiency and 10 per cent from labour.
• Changing growth model: The growth model is changing to an infrastructure and manufacturing-driven one.
• Capital spending: The Union Budget has raised capital spending by almost a third in high-multiplier infrastructure segments. But such support to capex will moderate in the years to come, given fiscal consolidation pressures.
• Investment ratio: Investment as a percentage of GDP has already touched a decadal high of 34 per cent in fiscal 2023. So far, the onus to lift the investment ratio has been shouldered by the government. The contribution of the private sector to investments is set to improve, primed as it is with healthier balance sheets, cash reserves and low leverage.
• Contribution of productivity to growth: The creation of physical and digital infrastructure in conjunction with efficiency-enhancing reforms will raise the contribution of productivity to growth. The economy is expected to continue seeing efficiency gains from reforms such as GST and Insolvency and Bankruptcy Code (IBC).

What is holding back a swift and broad-based lift in private investments?

• Economic uncertainty, primarily, and geopolitical events to a lesser extent.
• Sustainability challenge looms for the manufacturing sector as manufacturing and infrastructure growth are carbon-intensive.
• Low-quality skilling of the workforce is holding back its contribution to growth.
• Quality and the skilling of the workforce
• Falling labour force participation of women

What is holding back in Labour’s contribution to growth?

• Labour’s contribution to growth is likely to be low not because India does not have sufficient people in the working-age group, this cohort is 67 per cent of the population and is set to expand by 100 million over the next decade. It is the quality and skilling of the workforce that is holding it back.

Why private investment is essential for Indian economic growth?

• Capital formation: Private investment helps in creating capital formation, which is essential for economic growth. It helps in building infrastructure, creating jobs, and generating income, which in turn drives consumer spending and boosts economic growth.
• Innovation: Private investment is often associated with innovation and technological advancements. Companies that invest in research and development (R&D) can develop new products and processes that can boost productivity and create new markets. This, in turn, can lead to increased profits and more investment in R&D, creating a virtuous cycle of innovation and growth.
• Employment: Private investment creates jobs, which is critical for economic growth and development. When companies invest in new projects or expand their operations, they often need to hire additional workers, which reduces unemployment and boosts consumer spending.
• Foreign investment: Private investment is also an important driver of foreign investment. When companies invest in India, they often bring new technology, skills, and expertise that can help boost local industries and drive economic growth.
• Tax revenue: Private investment can also help increase tax revenues, which can be used by the government to fund public goods and services such as education, healthcare, and infrastructure.

Steps taken by the government to encourage private investment

• Investment-Friendly Policies: The Indian government has launched several investment-friendly policies, such as Make in India, Start-up India, and Digital India, to encourage private investment in the country.
• Infrastructure Development: The government is investing heavily in infrastructure development, including roads, railways, airports, and ports, to create a conducive environment for private investment.
• Tax Reforms: The Indian government has implemented several tax reforms, such as the Goods and Services Tax (GST), to simplify the tax structure and make it more investor-friendly.
• FDI Liberalization: The government has liberalized foreign direct investment (FDI) norms in several sectors, including defense, insurance, and retail, to attract more foreign investment.
• Insolvency and Bankruptcy Code (IBC): The government has implemented the Insolvency and Bankruptcy Code (IBC), which has made it easier for businesses to exit, and has increased investor confidence in the Indian economy.
• Production Linked Incentives (PLI): The government has launched the Production Linked Incentives (PLI) scheme to encourage manufacturing in India and make it more competitive globally.
• Easing of Business Regulations: The Indian government has eased several business regulations to improve the ease of doing business in the country and attract more private investment.
• Skill Development: The government has launched several initiatives, such as Skill India and Pradhan Mantri Kaushal Vikas Yojana, to develop the skills of the Indian workforce and make it more attractive to investors.

Facts for prelims: Steps taken by the government to encourage labour force participation of women

 Way ahead

• Focus on green transition: As the manufacturing and infrastructure growth are carbon-intensive, so it’s important to have a significant and simultaneous focus on green transition. Having a high sustainability quotient can only embellish India’s credentials as a production destination.
• For instance: Research suggests that between fiscals 2023 and 2027, over 15 per cent of India’s capex could be towards green initiatives involving renewable energy, transportation, altering the fuel mix, and green hydrogen. In the fragmented geopolitical milieu, which is shifting towards supply-chain diversification and friend shoring, India can attract foreign investments.
• Enhancing labour force participation of women: The labour force participation of women is falling. This will have to be reversed through employment policies and investing in the health and education of women.
• For instance: According to a World Bank report in 2018, India could add 1.5 percentage points to its GDP growth by improving the participation of women in its workforce.

Conclusion

• India is going to become a $5 trillion economy by fiscal 2029, given the current growth dynamics. However, the impact of climate risk mitigation will be felt across revenue, commodity prices, export markets, and capital spending. To win the growth marathon, India’s focus must be sharp on the drivers of pace.

Mains Question

Q. Highlight India’s growth prospects in the next five years? Discuss the significance of private investment for economic growth and enlist factors that holding back the private investment.

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Central Idea

• The RBI has decided to not increase the repo rate amid continuing hikes by important central banks such as the US Federal Reserve (Fed) and European Central Bank (ECB), and domestic inflation concerns. However, if incoming data point to rising inflation risks, this decision could prove to be only a pause in the rate hiking cycle.

The RBI’s decision to pause on rate hikes

• The RBI feels that money market rates have effectively risen more than the 250-basis-point yank in the repo rate since May 2022, and hence it decided to pause and assess the impact of rate hikes.
• The key reason behind the MPC decision is the expectation of a decline in inflation to 5.2% in the current fiscal, driven by a healthy rabi crop, normal monsoon, moderating international commodity prices, and the impact of rate hikes.
• The RBI acknowledges the upside risks and stated its readiness to fight any unexpected rise in inflation.

Impact on GDP growth

• The RBI expects GDP growth to slow to 6% from 7% this fiscal as slowing global growth, domestic interest rates, and messy geopolitics bite.
• Slowing global growth will be net negative for India’s exports, and the growing dependence on commodity exports makes India more vulnerable to global growth volatility.
• Fiscal 2024 will, therefore, test the resilience of India’s domestic demand amid rising interest rates.

Reasons for the expected cooling of consumer inflation

• Fuel inflation expected to reduce: Fuel inflation is expected to reduce to 3% from a high of over 10% in the current fiscal because some easing of crude oil prices is likely as global growth slows down.
• Decline in core inflation: Slowing domestic growth will ease core inflation from very sticky levels of over 6% last fiscal to 5.5% in the current one. However, the decline in core inflation will be limited as input cost pressures have not dissipated. To protect their margins, firms will continue to pass on input costs to end-consumer. Services inflation will also continue to exert pressure as the rotation of consumption demand from goods to services continues.
• Moderate food inflation: Food inflation, which has a high weightage in the Consumer Price Index and has driven headline inflation in the past, is projected to moderate to slightly below 5%, assuming a normal monsoon. However, food inflation has always been volatile and carries upside risks largely because of climate-related factors affecting agriculture output and prices.

How slowing global growth will have a negative impact on India’s exports?

• The impact of the growth slowdown in the US and Europe is deeper than the recovery in China: The US and Europe have a combined GDP that is twice that of China. Therefore, the impact of the growth slowdown in the US and Europe will be deeper than the recovery in China. This will have a negative impact on India’s exports to the US and Europe.
• India’s exports to the US and Europe are more than to China by a factor of six: India exports more to the US and Europe than to China by a factor of six. Therefore, the negative impact of the growth slowdown in the US and Europe will be felt more by India than by China.
• India’s growing dependence on commodity exports makes it more vulnerable to global growth volatility: India’s exports of petroleum products and steel are growing, and this makes India more vulnerable to global growth volatility. As global growth slows down, demand for commodities is likely to decline, which will have a negative impact on India’s exports.

External vulnerabilities

• India’s external vulnerability is expected to decline with a narrower current account deficit (CAD) and modest short-term external debt.
• The CAD is expected to narrow to 2% of GDP this fiscal from an estimated 2.5% last fiscal.

Conclusion

• The RBI’s decision to pause on rate hikes is driven by expectations of a decline in inflation. However, inflation risks remain, and the impact of rate hikes on GDP growth is expected to be significant. India’s external vulnerabilities are expected to decline, but the banking turmoil playing out amid interest rate hikes by important central banks and elevated debt levels remains a risk. The RBI’s decision to pause on rate hikes will be closely watched, and further rate hikes may be necessary if inflation risks persist.

Mains Question

Q. Enumerate the factors that led RBI to pause on rate hikes, and discuss the potential risks and impacts on the Indian economy?

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Central Idea

• The current paradigm of economics in India is inadequate in providing solutions to the three major economic challenges the country is facing. The economists need to break out of their self-referential silo and examine the science of complex self-adaptive systems.

The Poly-crisis faced by India

• The Indian government is grappling with three economic challenges at the same time:

1. Management of inflation,
2. Trade agreements, and
3. Employment

• Economists do not have a systemic solution for this poly-crisis. Consensus among them has broken down even about solutions to its separate parts.

Lessons from China and Vietnam

• Foreign investment in China: China and India opened their economies to global trade around the same time, some 35 years ago. Since then, China attracted foreign investment that was many times more than in India, and the incomes of its citizens increased five times faster.
• Vietnam emerging as more attractive destination: To attract investors, India must compete with other countries. Vietnam is often cited as a country that is proving to be more attractive than India to western and Japanese investors. However, when looking into Vietnam, they rediscover what was learned from China.
• High levels of human development: When both countries opened to foreign investors China before Vietnam, they had already attained high levels of human development, with universal education and good public health systems.

The Problem with the Current Paradigm

• There are some fundamental flaws in the current paradigm of economics.
• Economists often cite Tinbergen’s theory, which states that the number of policy instruments must equal the number of policy goals. This is a mechanical and linear view of how a complex system works.
• In complex organic systems, root causes contribute to many outcomes. The behaviour of the system cannot be explained by linear causes and effects. The causes interact with each other, and effects also become causes.

Facts for prelims: What is Tinbergen’s theory?

• Tinbergen’s theory states that the number of policy instruments (P) must be equal to the number of policy goals (G), in order to achieve the desired outcome.
• In other words: P = G
• This means that for each policy goal, there should be at least one policy instrument to achieve it.
• For example, if the policy goal is to reduce inflation, then there should be a policy instrument such as interest rate changes to achieve that goal. Similarly, if the policy goal is to promote employment, then there should be a policy instrument such as job creation programs to achieve that goal. Tinbergen’s theory emphasizes the importance of having a clear and consistent policy framework to achieve desired outcomes

Crises and the Inadequacy of the System

• Policies that fit one country may not fit the needs of others: Macro-economists search for global solutions, but trade and monetary policies that fit one country may not fit the needs of others. Their needs have emerged from their own histories.
• Emphasis on data trends: Economists arrive at solutions by comparing data trends of different countries, and in their models, people are numbers. Economists do not listen to real people, whereas politicians try to at least.
• For instance: The inadequacy of the current paradigm was revealed by several crises in this millennium, the 2008 global financial crisis, inequitable management of the global COVID-19 pandemic, and the looming global climate crisis.

Conclusion

• A new economics is required to solve the poly-crisis faced by India. A movement to change the paradigm of economics’ science to bring perspectives from the sciences of complex self-adaptive systems has begun even in the West. India’s economists must step forward and lead the change towards a new economics paradigm based on the sciences of complex self-adaptive systems. India’s policymakers will have to find a way to strengthen the roots of the economic tree while harvesting its fruits at the same time, and the current paradigm of economics cannot provide solutions.

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Central Idea

• The Chinese government’s growth target of 5% for 2023 has disappointed observers, given that it is lower than last year’s target and below the expected GDP growth for India in 2023. This is all the more surprising if one considers that India is benefiting from the positive impact of the country reopening after COVID-19 lockdowns while China should benefit from its reopening only this year.

Reasons for China’s lower growth target?

• Risk of undershooting growth target again: The Chinese government does not want to run the risk of undershooting its growth target again, as it happened in 2022.
• Weak external demand and doubts about private investment: Even if consumption is recovering, external demand remains weak and it is hard to know whether private investment will indeed rise given the doubts about the role of the private sector in the Chinese economy as well as increasingly cautious sentiment being expressed by foreign investors.
• Real estate sector dragging down growth: The real estate sector is still dragging down growth.

Sustainable growth

• The Chinese government recognizes that too high a growth rate is no longer desirable, as it only aggravates financial imbalances.
• Instead, they are promoting sustainable growth, which involves a structural shift of the Chinese economy and the implementation of tighter regulatory measures to contain financial risks and achieve more social objectives, such as a green economy and food security.

Job creation and foreign investment

• China emphasises the importance of job security as an objective of sustainable growth, with a higher target for new jobs set by the Chinese government.
• China’s recent charm offensive to retain foreign direct investment in China is an important source of job creation, given the country’s concern about the job market, especially young workers.
• However, investors are looking at new pastures, with India likely to be a major beneficiary. Foreign investors are beginning to contribute more substantially to job creation in India, which could pose challenges for China as it tries to hold on to foreign direct investment within the country.

Comparison of India and China’s growth prospects

• The growth prospects of India and China, with a focus on job creation and competition for foreign direct investment.
• while India and China may not be too different in size and population, growth prospects differ substantially.
• The Chinese government’s cautious growth targets are consistent with the current challenges facing the Chinese economy, but they face more competition than before, especially from India, which has a larger market size and labor pool.
• This pattern of India’s resilient growth and China’s cautious growth targets will accelerate in the next few years, especially if the reshuffling of the value chain continues, pushed by geopolitics and high costs in China.

Conclusion

• The Chinese economy could be facing structural deceleration while India enjoys the benefits of its demographic dividend. China’s structural deceleration and tighter regulatory measures may also affect its future growth prospects. As a result, India may be better positioned for sustained growth compared to China in the coming years.

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Central Idea

• The National Statistical Office (NSO) has released a new set of data on India’s annual and quarterly national income, providing a final assessment of the COVID-19 pandemic’s impact on the country’s GDP growth. The latest numbers and sector-wise performance, highlighting areas of growth and contraction.

Recovery since pre-COVID year

• Advance estimates: NSO’s second advance estimate (SAE) shows a contraction of (-) 5.7% in 2020-21, lower than its first advance estimate (FAE) at (-) 7.7%.
• Benefited sectors: Manufacturing, construction, and financial sectors benefited the most in the revised estimate.
• GDP growth: Real GDP in the COVID-19 year amounted to ₹136.9 lakh crore, higher than the earlier assessment of ₹134.4 lakh crore. GDP grew by 9.1% in 2021-22 and 7% in 2022-23.
• Negative growth in 2020: The compound annual average growth rate between 2019-20 and 2022-23 was 3.2%. Comparison with other countries, including China, Bangladesh, and Vietnam, shows India’s negative growth rate in 2020.

Back to basics: Advanced estimates

• Advance estimates refer to the preliminary projections made by the government regarding the likely economic growth, inflation, or other macroeconomic indicators of a country for a given period. These estimates are usually released a few months before the actual data for the period becomes available.
• Advance estimates are based on various economic indicators such as industrial production, agricultural output, exports, and consumption expenditure, among others. These indicators are used to extrapolate the economic activity for the full period, based on which the government makes its initial projections.

Sector-wise Performance

• Overall GVA in 2022-23 is higher by 11.3% compared to 2019-20.
• Mining and quarrying sector still shows a contraction at (-) 0.3%.
• Trade, hotels, transport, etc., show weak growth of 4.3%.
• Construction sector shows higher-than-average growth at 18.6%.
• Manufacturing sector also shows robust growth at 14.8%.
• Financial, real estate, etc., grew at 14.3%.
• Agriculture sector grew at 12%.
• Government final consumption expenditure (GFCE) grew at 7.4%.
• Gross fixed capital formation and private final consumption expenditure (PFCE) increased by 17.7% and 13.1%, respectively.

Investment and Capacity Utilization

• Gross fixed capital formation to GDP ratio in nominal terms increased to 29.2% in 2022-23 from 28.6% in 2019-20.
• Real investment rates increased to 34% in 2022-23 from 31.8% in 2019-20.
• Estimated incremental capital output ratio (ICOR) decreased to 4.9 in 2022-23 from 8.5 in 2019-20.
• Capacity utilization ratio in the manufacturing sector was only 70.3% in 2019-20, but it increased to 73.5% in the first half of 2022-23.
• Subdued growth implies lower capacity utilization and higher ICOR.

Quarterly Growth and Projections

• Q3 2022-23 saw a decline in real GDP growth to 4.4% from 6.3% in Q2 and 13.2% in Q1.
• Growth rate in Q3 and expected growth rate in Q4 are quite low.
• High frequency indicators point towards improved economic activity.
• PMI manufacturing in January and February 2023 remained above its long-term average.
• PMI services increased to a near 12-year

Conclusion

• the NSO’s latest data on India’s GDP growth provides a final assessment of the COVID-19 pandemic’s impact on the country’s economy. The NSO’s data shows that India’s economy is recovering, albeit at a slower pace, from the COVID-19 pandemic.

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Central Idea

• As per the RBI’s quarterly statistics, the current account deficit (CAD) widened to 4.4 per cent of GDP in the second quarter of 2022-23, down from 2.2 per cent in the preceding quarter. This marks a reversal from an unusual surplus of 0.9 per cent of GDP in 2020-21. In the third quarter of this financial year, while the merchandise trade deficit has widened, the CAD may witness a fall.

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What is Current Account Deficit (CAD)?

• Current Account Deficit (CAD) = Trade Deficit + Net Income + Net Transfers
• A current account is a key component of balance of payments, which is the account of transactions or exchanges made between entities in a country and the rest of the world.
• This includes a nation’s net trade in products and services, its net earnings on cross border investments including interest and dividends, and its net transfer payments such as remittances and foreign aid.
• A CAD arises when the value of goods and services imported exceeds the value of exports, while the trade balance refers to the net balance of export and import of goods or merchandise trade.

Components of Current Account

1. Trade Deficit

• Trade Deficit = Imports – Exports
• A Country is said to have a trade deficit when it imports more goods and services than it exports.
• Trade deficit is an economic measure of a negative balance of trade in which a country’s imports exceeds its exports.
• A trade deficit represents an outflow of domestic currency to foreign markets.

2. Net Income

• Net Income = Income Earned by MNCs from their investments in India.
• When foreign investment income exceeds the savings of the country’s residents, then the country has net income deficit.
• Net income is measured by Payments made to foreigners in the form of dividends of domestic stocks, Interest payments on bonds and Wages paid to foreigners working in the country.

3. Net Transfers

• In Net Transfers, foreign residents send back money to their home countries. It also includes government grants to foreigners. It also Includes Remittances, Gifts, Donation etc.

India’s CADs have both desirable and undesirable components

• Desirable:
• A desirable deficit is a natural reflection of rising investment, portfolio choices and the demographics of the country.
• If CADs can be financed by stable capital inflows, such as FDI inflows, they are desirable as they are less prone to capital flight.
• Stable capital flows are desirable as they allow debtor countries, such as India, to utilize and allocate them into sectors that may yield long-term productive gains and foster higher economic growth.
• Undesirable:
• Large and persistent CADs can be undesirable if they reflect bigger problems such as poor export competitiveness and are financed by unstable financing.
• If deficits are financed by volatile capital flows such as portfolio flows, there may be a cause of concern. Portfolio flows are capricious and more susceptible to reversals in case of any global financial shock.

The countercyclical nature of India’s CAD: A matter of concern

• Dominance of external shocks: Research suggests that the country’s CAD rises when output falls rather than when demand rises, indicating the dominance of external shocks.
• For instance: If oil prices rise, and as oil is an input in the production process, it raises the cost of production and leads to a fall in economic growth. In this case, CADs rise with falling growth due to both the inelasticity of oil import demand as well as its major share in India’s total imports.

Remarks to be Noted

• Remittances and services exports have provided a counter-balance to rising merchandise trade deficits.
• India’s services exports grew at 23.5 per cent in 2021-22.
• While capital flows are pro-cyclical and react negatively to contractionary monetary policy by the Fed, remittances have exhibited remarkable stability.

Challenges and a Way ahead

• The composition of financing is crucial. While FDI inflows were enough to finance the deficit in 2021-22, these inflows have been weak in the current fiscal year.
• Over the medium term, policymakers need to arrest the negative spillovers from the slowdown in global trade on merchandise exports.
• Further rate hikes by the US Fed may lead to capital outflows leading to additional exchange rate market pressures. This could be challenging in the current situation as a weaker currency, coupled with a sticky import basket will lead to imported inflation.
• Policy measures thus must facilitate exports by focusing on structural reforms to improve trade competitiveness, alongside which the government must sign free trade agreements.

Conclusion

• India is currently facing the twin-deficit problem of high fiscal and CADs. While aggressive fiscal consolidation may be undesirable in the face of rising fears about a global slowdown, a comfortable external environment can be maintained by ensuring stable financing, along with using exchange rates as a shock absorber to weather the adverse global economic situation.

Mains Question

Q. Explain the concept of Current account deficit? India’s CAD have both desirable and undesirable components. Discuss.

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Context

• On 25 January, US-based Hindenburg Research put out a tweet, talking about a negative report on the Adani Group that it had published. The report made many allegations against the group which triggered a fall in the price of their listed stocks.

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Just think of this situation

• A research report is released by a global firm that is also a short seller (that is, one who sells shares that it does not own, but buys them back at a lower price once the price falls).
• The report outlines areas of concern in a company that is listed in another jurisdiction. The issues raised could relate to the firm’s accounting or market practices.
• The report is released, quite curiously, before the company is going in for an equity issuance.

What happens after the news?

• Panic sale: As equity markets run on sentiments, such news leads to a panic sale and the share price of the company comes down sharply.
• Widespread uncertainty: The market sees investor wealth eroding sharply, leading to widespread uncertainty, as this is how contagions progress.
• Outrage: Denials are issued by the concerned company while the short seller stands firm on its views. However, shareholders have seen an erosion in their wealth and there is outrage everywhere.

In such a situation, what can the regulator do?

• Policies and system in place to put verified facts in public domain: It is for regulators in other jurisdictions to have policies/systems in place for verified facts to be put in the public domain.
• In the current context: The Securities and Exchange Commission of the US would matter and if the broker complied with its rules, then there is nothing to stop their views from being aired in a globalised world. This is why it is said that if any company opts for listing in overseas markets, there is more reason to ensure that its accounts are in place and there are no deviations from best practices.

What can regulators do to protect investors?

• It is necessary to understand that when share prices tumble: Only when someone sells the shares that have declined in value will a loss be actually incurred. This is the first point that ordinary investors need to keep in mind. While the media will talk of the loss of value and wealth, it is notional for those shareholders who don’t sell. And stock prices will return to their equilibrium once the storm passes.
• There is a need to have a wide market intelligence network: A special division that continuously analyses the messaging about Indian companies across the world. Given that such reports do not come up without signals being sent along the way, monitoring of views on companies listed overseas would be essential.
• While citing financial accounting irregularities need to be looked into: the accounting and auditing firms need to take on more responsibility to ensure that the Generally Accepted Accounting Practices (GAAP) are followed for overseas-listed firms. They will have to be made partners in any such crisis in terms of taking ownership and clarifying the same.
• Detecting price manipulation: Price manipulation, for instance, is one practice that has always been a concern for regulators. And it takes a lot of experience to detect it. Thus exchanges need to ensure that their market watch and surveillance practices are robust. This is where trading patterns can show if there has been market manipulation.
• Restoring assurance and sanity in the market: It is necessary that investors have some assurance from the regulator, which may be needed to restore sanity in the markets. However, this should be an immediate and time-bound investigation which looks at the allegations or the shortcomings of the report.
• Investing derivative segments too: As a corollary, the regulator needs to investigate the derivative segment too and probably talk to other regulators to analyse how the short positions have been created and whether they were in order. This will mean being in touch with other regulators, especially the SEC which regulates the jurisdiction for most overseas listings.
• Audit firms can be employed to flag off the concerns: The regulator should insist that all overseas listed companies have regular investor calls with stakeholders where meetings are recorded and transmitted back home for special teams to examine so that there is a sense of how potential investors feel about the companies.

Conclusion

• In the cases of overseas reports, investors must have some assurance from the regulator, which can restore sanity in the markets. But investors also need to be proactive when investing. Those who are more active investors would perhaps need to be aware of developments in the companies that they have invested in.

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Context

• The Reserve Bank of India (RBI) just-released State of the Economy report. The report suggests that while controlling inflation was a big concern in 2022, the bank may now be more focused on avoiding a recession in 2023. There is still debate about whether the recession will be short and mild or long and severe.

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What is State of the Economy report?

• A State of the Economy report is a paper that the Reserve Bank of India (RBI) releases which gives a summary of how the country’s economy is doing.
• The report talks about things like prices going up, how much the economy is growing, how many people have jobs, and the bank’s plan for managing money.
• The RBI uses the report to make decisions about interest rates and other economic rules, and it also helps people like economists, investors, and regular citizens understand the economy and make smart choices.

What the RBI’s State of the Economy report says?

• Retail inflation eased: Retail inflation eased to 5.72 per cent in December. In November, the inflation print was 5.88 per cent. The government has mandated the central bank to keep inflation at 4 per cent with a +/- 2 per cent band.
• Consumer price inflation within RBI’s upper tolerance limit: The report said the country’s macroeconomic stability is getting bolstered with inflation being brought into the tolerance band. consumer price inflation in the last two months falling within the RBI’s six per cent upper tolerance limit
• Hopeful for the fiscal consolidation: It is even hopeful of fiscal consolidation underway at central and sub-national levels and the external current account deficit on course to narrow through the rest of 2022 and 2023. RBI said in a report that they want to keep prices steady at a certain level and bring it down to 4% by 2024.
• Narrowing CAD: Lead indicators suggest that the current account deficit is on course to narrow through the rest of 2022 and 2023.
• Stock market continue to outperform peers: The country’s stock markets stood out in 2022 and continue to outperform peers on the strength of macroeconomic fundamentals and retail participation.

Who prepares the report and what the authors says?

• Views expressed are not of the institution: The report was prepared by RBI’s deputy governor Michael Patra and other RBI officials. The views expressed in the report are of the authors and not of the institution, the report said.
• India at a bright spot: Authors said the prospect of India as a bright spot amidst 2023’s encircling gloom is burnished by most recent history and current developments. By cross-country standards, the country’s economy exhibited resilience through 2022 in the face of the triad of shocks war; monetary policy tightening; and recurring waves of the pandemic.
• India will be ahead of UK: According to the authors, at current prices and exchange rates, India will still be the 5th largest economy in the world in 2023, worth $3.7 trillion and will be ahead of the UK.

Back to basics: What is Monetary policy?

• Monetary policy is the macroeconomic policy laid down by the central bank.
• It involves the management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
• A contractionary policy increases interest rates and limits the outstanding money supply to slow growth and decrease inflation.
• During times of slowdown or a recession, an expansionary policy grows economic activity, by lowering interest rates, saving becomes less attractive, and consumer spending and borrowing increase.

What are the concerns and prognosis over the report?

• Predictions are too optimistic: The report’s release is significant, as it comes before the Union Budget for 2023-24. However, the report’s predictions may be too optimistic.
• Risks tilted towards growth than inflation: The balance of risks is currently tilted towards growth rather than inflation, both globally and domestically.
• Slowing down the pace of monetary tightening: It is appropriate for the RBI to slow down or pause the pace of monetary tightening. Monetary policy takes time to have an effect, so the impact of these increases may take a few quarters to realise actually.
• Wait and Watch Approach: The RBI can afford to adopt a wait-and-watch approach and allow the impact of past actions to be fully felt. This does not mean neglecting inflation, as bringing it down to 4% is still important.

Conclusion

• The world is, no doubt, viewing India favourably as an investment destination, both for its large domestic market and the need to de-risk from China in the current geopolitical environment. The government’s focus on improving the country’s physical as well as digital infrastructure is boosting the investors’ confidence. Demonstrating macroeconomic stability and policy credibility can be the icing on the cake to bring the world to India.

Mains question

Q. Highlight RBI’s State of the Economy report and discuss what makes India a favorable investment destination?

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Context

• The Indian economy is expected to grow at 7 per cent in 2022-23 as per the first advance estimates of national income released by the National Statistical Office (NSO) on Friday. This is marginally higher than the RBI’s most recent assessment in the December monetary policy committee meeting, the central bank had lowered its expectation of growth to 6.8 per cent.

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Estimate: Indian economic growth

• As per the latest estimates growth is likely to slow down in later half: Considering that the economy grew by 9.7 per cent in the first half of the financial year (April-September), the latest estimate implies that growth is likely to slow down to 4.5 per cent in the second half of the year (October-March) as the base effect wanes.
• Full year growth estimates India will be fastest growing economy: Notwithstanding that, the full-year growth estimate suggests that India will be one of the fastest-growing economies in the world.

Positive signs in the Indian Economy

• Positive medium-term growth prospects: Company and bank balance sheets are healthier, credit growth is rising, and capacity utilisation has increased, all of which augur well for investment activity.
• Positive impact on tourism: The waning of Covid-19 should hopefully have a positive impact on travel, transport and tourism. Construction activity should pick up further with the reduction in housing inventory and almost stable prices over the last decade.
• On inflation India is doing better: On the inflation front, India is doing better than many advanced economies and emerging markets.

Areas of concern

• Private consumption is likely to contract in the second half of the year: While the pace of contraction is expected to be marginal, the slowdown in spending could be due to either the exhaustion of pent-up demand or the lagged impact of a tighter monetary policy.
• Exports growth likely to grow: As per the estimates, exports are likely to grow at almost 12 per cent in the second half of the year. This is at odds with recent data which showed that export growth has actually slowed down considerably as advanced economies have come under pressure.
• Agriculture growth likely to slow down: Agricultural growth is expected to slow down in the second half. As per some analysts this is not in sync with the healthy sowing rates and reservoir levels.
• Manufacturing will go upward: The manufacturing sector, which was almost flat in the first half of the year, is expected to witness an uptick in the second half. It is difficult to reconcile this with the view that both domestic demand and exports are likely to remain subdued, which would in turn impact industrial production.
• Government spending will remain almost flat: Public administration, defence and other services, which largely connotes government spending, is expected to remain more or less flat in the second half. This is odd considering that government consumption expenditure is pegged to grow at 7.2 per cent during the period.

As the data is not yet concrete, estimates made are likely to change

• As the first advance estimates suffer from data limitations, they are based only on seven to eight months of data these are likely to change once more data is available.
• However, they do provide some sense of underlying momentum in economic activities, and are useful in the context of the upcoming Union budget.
• The last budget had assumed a nominal GDP growth of 11.1 per cent. However, as per the latest estimates, nominal GDP is expected to grow at a significantly higher pace of 15.4 per cent.

Conclusion

• Along with trends in tax collections as per which the government’s revenues will surpass budgeted targets by a significant margin, these growth estimates only increase the likelihood of the Centre meeting its budgeted fiscal deficit target for the year.

Mains question

Q. As per the first advance estimates of national income released by the National Statistical Office, Indian economy is expected to grow at 7 per cent in 2022-23. In light of this discuss some of the latest projections and the areas of concern for Indian economic growth.

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Context

• The new year begins on a slightly more optimistic note for India. Global crude and food prices are down, the rupee has stabilised at 82-83 to the dollar after dropping from 74.5 levels at the start of 2022, even as official foreign exchange reserves have recovered. However, there are challenges to the economic growth of India which needs an immediate attention and action.

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The current scenario and the optimism around Indian economy

• Global crude and food prices: Global crude and food prices are roughly 38 per cent and 15 per cent down respectively from their highs in March, following Russia’s invasion of Ukraine.
• Stabilised rupee: The rupee has stabilised at 82-83 to the dollar after dropping from 74.5 levels at the start of 2022
• FOREX recovered: even as official foreign exchange reserves, which had plunged to $524.5 billion on October 21 from a year-ago peak of $642 billion, have since recovered to $562.8 billion.
• Environmental conditions are good for Rabi crops: With the prospects for the upcoming rabi crop looking good, as there is favourable soil moisture conditions, timely onset of winter and improved fertiliser availability on the back of declining international prices one can expect consumer inflation to ease further.

What is inflation?

• Inflation is an increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices. Typically, prices rise over time, but prices can also fall (a situation called deflation).

What are the challenges?

• Challenge is more on growth than on Inflation: The challenge for India this year is likely to be more on the growth than on the inflation front.
• It seems, Chinese’s authoritarian policies making India a favourable investment destination: On paper, the world’s disillusionment with China (more specifically, the authoritarian policies of Xi Jinping, both at home and beyond) and its diminishing economic prospects, worsened by a looming demographic crisis, should be making India every investor’s favourite destination.
• On paper government efforts are honest to attract investment: The present government’s focus on improving the country’s physical as well as digital infrastructure plus schemes such as production-linked incentive to attract investments in specific sectors, from solar photovoltaic modules and drones to specialty steels ought to have given added impetus to this process.
• But on the ground, neither domestic nor foreign companies are really investing: The biggest drag on investment during the last decade was over-leveraged corporates and bad loans-saddled banks.
• Deepening global slowdown is a major challenge to the economic growth: That twin balance sheet problem has more or less resolved itself. Today’s problem has mainly to do with strained government and household balance sheets. That, coupled with a deepening global slowdown constricting export demand, could have a bearing on India’s economic growth.

What is Current Account Deficit (CAD)?

• A current account is a key component of balance of payments, which is the account of transactions or exchanges made between entities in a country and the rest of the world.
• This includes a nation’s net trade in products and services, its net earnings on cross border investments including interest and dividends, and its net transfer payments such as remittances and foreign aid.
• A CAD arises when the value of goods and services imported exceeds the value of exports, while the trade balance refers to the net balance of export and import of goods or merchandise trade.

What should the government do?

• Refrain from fiscal stimulus and maintain macroeconomic stability: It should certainly refrain from any fiscal stimulus to kick-start investment or drive growth. Far from stimulus, what the country needs is macroeconomic stability and policy certainty.
• Managing current account deficit: The current fiscal deficit and public debt levels are far too high to allow any new populist schemes in the name of putting money in people’s hands or sharp tax cuts to supposedly revive investor sentiment. Large government deficits will invariably spill over into current account deficits. The latter number, at 4.4 per cent of GDP in July-September, was the highest for any quarter since October-December 2012 and the prelude to the last so-called taper tantrum-induced balance of payments crisis.
• Must prioritize fiscal consolidation: The coming budget must prioritize fiscal consolidation. This will enable the RBI to also pause interest rate hikes and further monetary tightening, which is probably not the best thing for an economy already facing multiple growth headwinds.

Conclusion

• India’s challenge has shifted from inflation management to facilitating growth in 2023. Policy stability and credibility should be the mantra that will ultimately work for India.

Mains question

Q. It is said that the new year 2023 is starting on a slightly more optimistic note for the Indian economy. In this background, discuss the challenges facing India’s economy and what the government should do?

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Context

• There seems to be considerable optimism about India’s near-term growth prospects now that the major global energy and commodity shocks have subsided. Even if these shocks have subsided, India still faces one big problem of its large current account deficit (CAD). How will this be managed? It turns out that the answer to both questions lies in one word exports.

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What is Current Account Deficit (CAD)?

• A current account is a key component of balance of payments, which is the account of transactions or exchanges made between entities in a country and the rest of the world.
• This includes a nation’s net trade in products and services, its net earnings on cross border investments including interest and dividends, and its net transfer payments such as remittances and foreign aid.
• A CAD arises when the value of goods and services imported exceeds the value of exports, while the trade balance refers to the net balance of export and import of goods or merchandise trade.
• CAD = Trade Deficit + Net Income from Abroad + Net transfers

What has been the recent trend?

• Swelling CAD: Over the past year, the post-pandemic normalisation has caused the current account deficit to swell to exceptional proportions.
• Decline in demand abroad: At home, normalisation has spurred a renewed demand for imported inputs. But abroad, it has had the opposite effect, leading to a decline in demand.
• India’s import soared while exports fell: Foreign households are no longer demanding so many goods now that the lockdowns that kept them in their houses and the fiscal stimuli that gave them the money to spend have both ended. So, India’s imports have soared just at a time when its merchandise exports have started to fall.
• Statistics for instance: The difference between the value of goods imported and exported fell to $54.48 million in Q4FY 2021-22 from $59.75 million in Q3 FY2021-22.
• Service sector is saviour: However, based on robust performance by computer and business services, net service receipts rose both sequentially and, on a year, -on-year basis.

Future projections

• Looking ahead, the situation seems set to worsen: Foreign demand will slow further as advanced countries slip into what now seem like inevitable recessions.
• In the backdrop of recession India’s CAD could widen further: In that case, India’s CAD could widen even further, possibly to four per cent of GDP in 2022-23, double the level that the Reserve Bank of India (RBI) traditionally regards as “safe”.

Analysis: How should India respond?

1. Attracting foreign capital inflow: Attract foreign capital inflows worth at least four per cent of GDP.

• Is this realistic in time of global uncertainty: The world is currently facing unprecedented levels of uncertainty. Two years of the pandemic, now a land war in Europe, inflation and energy crisis in Europe, interest rate hikes in the history of the US Federal Reserve, slowdown in china, etc. In such an uncertain environment, foreign investors prefer to invest in safe assets such as US government bonds rather than emerging markets like India. As a result, India has witnessed large outflows of foreign capital in 2022-23

2. Deploying RBI’s Forex to pay for imports: If India cannot attract the required amount of capital inflows, the RBI’s foreign exchange reserves could be deployed to pay for imports.

• Is this strategy sustainable: The country’s reserves are meant to tide the country over short-term problems, such as commodity price spikes. India’s merchandise exports have been structurally weak, stagnating for the past decade, until the pandemic induced a short-lived boom.

How depreciating rupee could be helpful?

• Price needs to be adjusted by depreciating rupee: This means that something fundamental needs to change. Ultimately, India’s CAD reflects a mismatch between the demand and supply of foreign exchange. To restore balance, first and foremost, the price needs to adjust, that is, the rupee needs to depreciate.
• Exporting becomes more profitable: When this happens, exporting becomes more profitable, inducing more and more firms to explore foreign markets. Meanwhile, foreign demand improves, because the rupee depreciation makes India’s products more price-competitive. As a result, exports increase and the CAD falls.
• Exchange rate depreciation is helpful in sustained growth: The recovery of the Indian economy from the pandemic was largely fuelled by exports. But with exports now declining, this crucial source of growth has now become uncertain for India. Strengthening the export sector is, therefore, critical for sustaining growth.

Way forward

1. Allow the rupee to depreciate,
2. Encourage foreign firms to produce in India by letting them access their supply chains,
3. Encourage domestic firms to step up to the competition, and
4. Create a level playing field for all players.

Conclusion

• The large CAD, however, is not a short-term problem: It is a long-term problem requiring a long-term solution. By adopting the discussed strategy, India could potentially solve its two most important macroeconomic problems that are reducing the large CAD and securing rapid, sustained growth.

Mains question

Q. What is Current account deficit (CAD)? In a time of global uncertainty How India can reduce its large CAD and secure sustained growth. Analyze

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Context

• Several agencies, including the IMF and the World Bank have projected lower growth rates for the Indian economy in FY23, than the 7.2 per cent estimated by the RBI in April. The Central bank has now lowered its forecast to 6.8 per cent. Given the current situation, with the Q2 FY 2023.

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Current economic growth estimation

• Economy is likely to grow at 6.5-7.0 per cent: Given the current situation, with the Q2 FY 2023 GDP growth clocking in at 6.3 per cent, the economy is likely to grow at 6.5-7.0 per cent in this fiscal year.
• Considering economic uncertainties it is difficult to arrive at precise estimate: It is difficult to arrive at a precise estimate for growth this year with unprecedented economic uncertainty worldwide, including high global inflation, synchronized monetary tightening, and the impact of the Ukraine war.

Positive signs in the Indian Economy

• Positive medium-term growth prospects: Company and bank balance sheets are healthier, credit growth is rising, and capacity utilisation has increased, all of which augur well for investment activity.
• Positive impact on tourism: The waning of Covid-19 should hopefully have a positive impact on travel, transport and tourism. Construction activity should pick up further with the reduction in housing inventory and almost stable prices over the last decade.
• On inflation India is doing better: On the inflation front, India is doing better than many advanced economies and emerging markets.

What is Indian economy’s pressing problems specifically in terms of Labour-intensive growth?

• Employment a biggest concern: Employment, an issue that has persisted over the last two decades. In brief, we have not generated enough good jobs to match the scale at which the economy has grown, especially in the organised sector. As a result, we have very high under-employment and poor-quality employment, which have hampered a much-needed move away from agriculture.
• Lack of precise data on people living in poverty: We do not have a precise estimate of the current levels of poverty, as there has been no household consumption survey since 2011-12, and the 2017-18 survey was abandoned due to technical issues. But there is reasonable consensus that poverty could be around 10 per cent of the country’s population, A low number compared to the past, but as many as 140 million people could still be living in poverty.
• Lack of non-agricultural jobs: The rising demand for the MGNREGA, and the importance of food distribution schemes and other welfare programmes for the poor are indicators of the lack of non-agriculture jobs being generated.
• Lowest rate of women participation in labour force: An alarming aspect of the employment problem in India is the low participation rate of women in the labour force, which is among the lowest in the world. This loops back to the importance of labour-intensive manufacturing. For example, much of Bangladesh’s success, and that of Southeast Asian countries, in exports and manufacturing stems from the large number of women working in their factories.
• Women literacy is rising but increasing number of educated women are not working: A positive trend in India has been the growing trend in girls attending schools and college in the last 20 years, but this also means that an increasing number of educated women are not working.
• Despite of 1991 reforms still remains an untapped opportunity: With the LPG reforms, the expectation was that, as the economy opened up to global competition, India’s low wage levels would attract private investment into labour-intensive manufacturing, thus generating jobs. This was the path followed by the East Asian economies that experienced high growth and rapid development. But for India this remains an untapped opportunity.
• Manufacturing is shifting to countries other than India: Even with rising wage levels in China, manufacturing is shifting to countries other than India. The PLI (production-linked incentives) scheme has been rolled out to encourage manufacturing. It may need some tweaking to be biased towards labour-intensive manufacturing as China vacates space in this area. This may seem at odds with the more popular view that it is small and medium enterprises which promote employment.
• Country’s real exchange rate is not healthy: An overvalued rupee has discouraged the export of labour-intensive manufacturing goods, which are very price-sensitive in global markets. It has also had a dampening effect on domestic production as our currency has depreciated at a lower rate than other emerging economies like China and Indonesia.
• Depreciated rupee impacting domestic producers by inflow of cheaper imports: Domestic producers of goods that compete with imports into our markets have been impacted by the inflow of cheaper imports. This has disincentivised them from expanding production and generating employment.
• Micro, small and medium enterprises (MSMEs) are severally hit: Problems that have come to the fore post-pandemic include the health of micro, small and medium enterprises (MSMEs). Accurate information on this is somewhat scarce but anecdotal evidence suggests that they have been more severely hit than the formal sector.

Way ahead

• The rupee has been overvalued for long and needs to be allowed to depreciate, though in a calibrated way, ensuring external and financial stability.
• Job growth is crucial if we are to reduce the still high levels of poverty in the country
• Incentivizing the domestic producers so that they can compete with the cheaper inflow of imports and expands their manufacturing thereby generating employment in the economy
• The continued recovery of the formal sector, as indicated by various metrics, in terms of the improved health of corporates and banks should effectively pull up the MSMEs through supply chains linkages, among others.
• We still have a negative real interest rate (that is, the difference between the RBI’s policy rate and inflation). Hence, the policy rate needs to rise further, providing a push to financial savings, which are needed to generate higher investment for growth.
• Inflation need to be contained through supply-side measures as well, such as an improvement in the supply of food products.

Conclusion

• High under-employment and poor-quality employment have hampered a much-needed move away from agriculture. A focus on labour-intensive formal manufacturing is the need of the hour.

Mains Question

Q. India is showing positive signs of economic recovery however the economy still has a hangover from the past and some are exacerbated by Covid. Discuss.

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Context

• Notwithstanding the likely slowdown in economic momentum in the second half of the year, the Union government’s tax collections are on track to surpass its budgeted target by a significant amount this year.

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The current status Union government’s tax collection

• Gross tax collections have already touched the target: Data released by the Controller General of Accounts last week shows that gross tax collections have already touched 58 per cent of the full year’s target, growing by 18 per cent in the first seven months (April-October) of the current financial year.
• Healthy growth in corporate tax collection: Under the broad rubric of taxes, direct tax collections have grown by a robust 26 per cent in the first seven months of the financial year, with healthy growth being seen across both corporate and income tax collections.
• Higher than the nominal GDP growth: While the pace of direct collections has eased during July-October when compared to the first quarter, it continues to be higher than nominal GDP growth in the second quarter.
• Healthy indirect tax collection: On the indirect tax side, GST collections continued to witness healthy growth, recording an increase of 11 per cent in November.

Memory shot in short: Types of Direct Taxes

• Income Tax: Depending on an individual’s age and earnings, income tax must be paid. Various tax slabs are determined by the Government of India which determines the amount of Income Tax that must be paid. The taxpayer must file Income Tax Returns (ITR) on a yearly basis. Individuals may receive a refund or might have to pay a tax depending on their ITR. Penalties are levied in case individuals do not file ITR.
• Wealth Tax: The tax must be paid on a yearly basis and depends on the ownership of properties and the market value of the property.
• Estate Tax: It is also called Inheritance Tax and is paid based on the value of the estate or the money that an individual has left after his/her death.
• Corporate Tax: Domestic companies, apart from shareholders, will have to pay corporate tax. Foreign corporations who make an income in India will also have to pay corporate tax.
• Capital Gains Tax: It is a form of direct tax that is paid due to the income that is earned from the sale of assets or investments

What the Healthy tax collection imply?

• Higher devolution to states: Higher tax collections at the level of the central government imply that devolution to states will be higher than the budgeted amount of Rs 8.16 lakh crore. The months of August and November have in fact witnessed double instalments as the Centre has stepped up devolution.
• States can increase fiscal expenditure: Along with the interest free loan scheme extended by the Centre, higher devolution implies that states have considerable fiscal room to increase capital expenditure. However, this has not been the case so far. Capex by states has been rather muted.
• Provides comfort to governments fiscal arithmetic: As per recent statements by revenue secretary Tarun Bajaj, the government is now hopeful of exceeding the budgeted target by nearly Rs 4 lakh crore. With its spending also likely to surpass earlier expectations by a considerable margin, higher tax collections will provide some comfort to the government’s fiscal arithmetic.

Challenges on the expenditure side

• Increased subsidy bills: On the expenditure side, the Union government is facing a massive increase in its subsidy bill.
• Spending is more than actual budget: Actual spending on the food and fertilizer subsidy and also on LPG will be significantly higher than what has been budgeted for. This is likely to make the fiscal situation challenging.
• Effective utilization is necessary: Considering that the central government has maintained the momentum on its capital spending, growing by around 60 per cent in the first seven months of the year, the overall general government fiscal impulse will depend on how effectively states are able to utilise the extra space available to them.

Conclusion

• Calls for increasing spending to support the economy during this uncertain period will only gain traction as the budget approaches. The government must however resist the temptation. It should stick to the glide path of fiscal consolidation.

Mains Question

Q. In a time of possible economic slowdown, India’s tax collection is on a healthy path. Discuss what good tax collection means for economy?

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Context

• India’s economic growth slowed to 6.5 percent during the July-September quarter because of a fading low-base effect. For the full year, the economy is expected to grow at 7 percent, with risks tilted to the downside. This implies that the second half of the year (October–March) will see growth slow down to 4.6 percent, again largely due to the base effect and slowing global growth.

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Background: The COVID Pandemic, geopolitical tensions and the Prospects

• This was the second consecutive quarter with no functional disruption of economic activity caused by the COVID-19 pandemic.
• Since October, Google, too, has stopped reporting mobility indicators, which had become one of the most tracked data points for analysts and policymakers since the pandemic struck.
• This suggests that COVID-19 is unlikely to come in the way of growth for most parts of the world, with China, which is following a zero-COVID policy, being the key exception.

Performance of Indian economy amidst the current global slowdown

• Spill over effect in India: In an interconnected world, Geopolitical tensions, high and broad-based inflation in many parts of the world and sharp increases in policy rates in developed countries amid a looming recession will continue to confront the global economy. These effects will spill over to India as well, despite its structural strengths.
• Slow growth of contact- intensive service sector: Growing at 14.7 per cent, contact-intensive services such as trade, hotels and transport continued to be key drivers of the growth momentum in the second quarter. This segment had borne the brunt of the pandemic because of recurrent lockdowns, and is showing a strong rebound because of pent-up demand, a trend that is likely to continue this year.
• Strong private consumption: Private consumption was quite strong in the second quarter, growing by 9.7 per cent, and now 11.2 per cent above the pre-pandemic level.
• Rising domestic demand, good for the economy: The resilience of domestic demand will shape the contours of GDP growth in coming quarters as the global growth momentum is anticipated to lose steam. Advanced economies, whose growth is expected to slow sharply next year, account for almost 45 per cent of India’s merchandise exports.
• Strong and firm Agriculture sector: Despite climate-related disturbances, agriculture surprisingly held its ground in the second quarter.
• Healthy tax revenue: So far, healthy tax revenue collections have allowed the government to finance its bloated subsidy bill and investments without much pressure on the fiscal deficit. Led by government capex, investments grew 10.4 per cent in the second quarter.
• Good corporate balance sheets: strong corporate balance sheets not only cushion them against global headwinds but also provide an opportunity to kick-start the investment cycle once uncertainty subsides.

The current status of India’s manufacturing growth

• Slowed growth: Manufacturing GDP growth slowed rather sharply due to the base effect and margin pressure on manufacturing companies. This is somewhat contradictory to the relatively strong signals from the Purchasing Managers’ Index (PMI) which, at 55.9, was in the expansion zone during the July-September quarter, while also being slower than the IIP growth of 1.4 per cent in the same quarter.
• Support from the government: Currently, manufacturing is finding some support from government spending on infrastructure, particularly in sectors such as steel and cement. The production-linked incentive scheme has incentivised private investment and fast-forwarded manufacturing investments in electronics and pharmaceuticals.
• Overall demand is low except few high value segments: The festive season-related production and the continued strong demand in the automobile sector (especially in high-value segments), was not enough to prevent an overall slide in manufacturing.

The current status of Agriculture sector

• Strong and firm Agriculture sector: Despite climate-related disturbances, agriculture surprisingly held its ground in the second quarter. Although rains were 6 per cent above normal this year, they were quite lopsided and led to a drop in rice acreage in some of the rice-growing regions on account of rainfall deficiency and some damage to crops from excess unseasonal rains in October.
• Inconsistency in rainfall may affect kharif: In fact, October rains were 47 per cent above the long-period average. Rain shortfall in some regions, excess in others, and unseasonal excess rains point towards some hit to kharif production.
• Rabi crops look in good swing: That said, the prospects for the winter crop (rabi crop), which is largely irrigated, look good owing to favourable soil moisture conditions and healthy reservoir levels. While rabi sowing was initially delayed on account of unseasonal October rains, it is now progressing well, with sown area until November 18 about 7 per cent higher than during the same period last year.
• Overall agriculture growth prospects: This trend, if sustained, should offset the hit to kharif production to some extent. Overall, we expect agriculture to grow at 3 per cent this year, lower than the decadal average of 3.8 per cent.
• Food inflation: Abnormal weather has also triggered food inflation, particularly in cereals, which will cool off only when the prospects for rabi crop become clear. While fall in inflation in October was largely due to a high base effect, core inflation continues to be sticky and food inflation risks persists.

Conclusion

• India’s growth cycle has become well-synchronized with those of advanced economies. So, a sharp slowdown in these countries will spill over to India and the maximum impact of domestic interest rate hikes on growth will play out next fiscal given that monetary policy impacts growth with a lag. The key policy challenge for India will be to manage a soft landing amid the possibility of a hard landing in advanced countries.

Mains question

Q. COVID pandemic disrupted the global economy, moreover the geopolitical tensions are adding to the existing slow growth. In this context, discuss the current status of Indian economy.

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Context

• The Indian rupee has been quite the controversial newsmaker this year. Having fallen more than 11 percent against the US dollar so far in 2022, the rupee breached the much-feared 80-mark in July and went on to set record lows, touching 83 to a dollar late in October.

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Impact on trade

• Widening trade deficit: The first phenomenon is one of the biggest worries caused by a falling rupee, a rise in import costs, threatening higher inflation and a widening trade deficit.
• Advantage for export: However, there also exists a ray of hope, a depreciated currency implies cheaper, more competitive exports and therefore, a possible export-led boost to the domestic economy. The net effect of these opposing forces would determine the impact of a depreciating currency on an economy.
• Robust Purchasing Manager’s Index (PMI): The import bill has risen not only on the back of a raging dollar and hardening crude prices but has also been spurred by strengthening domestic demand and manufacturing, as evidenced by a robust Purchasing Manager’s Index (PMI) of 55.3 in October.
• Subdued merchandized export: Although service exports have done fairly well in FY 2022-23, merchandise exports have remained subdued and could soon worsen due to economic downturns in Europe and the US.

Impact on foreign investment

• Weak rupee low foreign portfolio investors (FPI): The rupee has a complicated relationship with the moody foreign portfolio investors (FPIs). A weaker rupee can discourage FPIs. In turn, FPI outflows can further push the rupee to depreciate.
• Falling NRI deposits: With the rupee losing value against the dollar, and interest rates around the world rising, NRI deposit flows also fell in the five-month period from April to August 2022, down to US$1.4 billion from US$2.4 billion a year ago.
• FDI is Rising: Net FDI flows have remained positive and are set to grow, with April-June 2022 seeing an inflow of US$13.6 billion, higher than the same period last year. Even Indian stock markets have remained resilient, particularly on the back of large net-purchases by domestic institutional and retail investors, offsetting the equity sell-off by foreign investors.
• Negative foreign investment: Net foreign investment (FII) flows did turn negative for a few months in 2022, and while rebounding FPI and resilient FDI do point to a more optimistic opinion of India among foreign investors, foreign investment is absolutely crucial at this juncture in India’s growth story and must be watched closely.

Efforts taken by RBI

• Use of forex reserve: In an effort to defend the rupee, the RBI has intervened and sold off some of its foreign exchange reserves. The reserves stood at US$524.52 billion as of 21 October 2022, witnessing a fall of over US$115 billion since the beginning of the year.
• according to RBI external situation is better: RBI has stated that most external indicators such as external debt to GDP ratio, net international investment position to GDP ratio and the ratio of short-term debt to reserves reflect India’s relatively comfortable position in meeting its external financing requirements–even in contrast to other emerging economies.
• Careful intervention: Over-tightening of monetary policy and excessive intervention in the currency market can pose significant risks to the country’s growth prospects and the RBI must be careful to intervene just enough to quell volatility, without expending an inordinate amount of reserves.

Opportunity in crisis

• Leveraging the growth rate: India has the chance to leverage its relatively healthy growth rates and rising infrastructure and capital expenditure to attract foreign investment, spurring growth and strengthening the capital account.
• High investor confidence: Investor confidence has been steady, with the country seeing a record high of annual FDI inflows of US$84.8 billion in FY2021-22 in spite of the pandemic and volatile geopolitical scenario.
• Stability in growth: This confidence needs to be leveraged and by positioning India on the international stage as a thriving and stable haven for investments, both the country’s growth and forex needs can be met.
• Sufficient policy support is needed: Although the falling rupee has caused worry for a few economic indicators, with sufficient policy support, the domestic economy could emerge as an outlier in a global downturn.

Conclusion

• With the United States (US) on a war path to curtail inflation and the supply side stifled by the conflict in Ukraine, even historically strong currencies like the euro and the British pound have plummeted against the raging dollar, more than the rupee. Government and RBI must stay on course of steady growth of economy.

Mains Question

Q. Discuss the impact of falling rupee on Trade and foreign investment in India? How India has unique opportunity for growth amidst the crisis around the world?

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Context

It is then apparent that GDP growth matters to the average Indian only if it can generate good quality jobs and incomes for them.

Background

• Nobel laureate Simon Kuznets, who conceived of GDP as a measure of economic performance, never intended it to be the single-minded economic pursuit for a nation that it has now become, and warned repeatedly that it is not a measure of societal well-being.
• Irrefutably, GDP is an elegant and simple metric that is a good indicator of economic progress which can be compared across nations.
• But a compulsive chase for GDP growth at all costs can be counter-productive, since it is not a holistic but a misleading measure.
• The excessive obsession over GDP growth by policymakers and politicians can be unhealthy and dangerous in a democracy.
• If growth in GDP does not translate into equivalent economic prosperity for the average person, then in a one person-one vote democracy, exuberance over high GDP growth can backfire and trigger a backlash among the general public.
• Global phenomenon: Sri Lanka’s mass uprising and people’s revolution can partly be explained through this prism of the structural break between headline GDP growth and economic prosperity for the people.
• The U.S. today produces fewer new jobs for every percentage point of GDP growth than it did in the 1990s.
• China produces one-third the number of new jobs today than it did in the 1990s for every percentage of its GDP growth.

Employment intensity of economic growth

• Data of ‘employment in public and organised private sectors’ published by the Reserve Bank of India (RBI) shows that in the decade between 1980 and 1990, every one percentage point of GDP growth (nominal) generated roughly two lakh new jobs in the formal sector.
• In the subsequent decade from 1990 to 2000, every one percentage point of GDP growth yielded roughly one lakh new formal sector jobs, half of the previous decade.
• In the next decade between 2000 and 2010, one percentage point of GDP growth generated only 52,000 new jobs.
• The RBI stopped publishing this data from 2011-12.
• In essence, one percentage of GDP growth today yields less than one-fourth the number of good quality jobs that it did in the 1980s.
• It is amply clear that the correlation between formal sector jobs and GDP growth has weakened considerably.

Implications of decline in GDP growth’s contribution to job creation

• Irrelevant as a political measure: GDP growth may be an important economic measure, but it is becoming increasingly irrelevant as a political measure, since it impacts only a select few and not the vast majority.
• Indicates changed nature of economic development: This divorce of GDP growth and jobs is both a reflection of the changed nature of contemporary economic development with emphasis on capital-driven efficiency at the cost of labour and GDP being an inadequate measure.
• Political backlash: The perils of the obsession over GDP growth will be felt by politicians who have to answer voters on lack of jobs and incomes despite robust headline growth.
• Voter disenchantment over the economy not working for them is already rife in many democracies across the world that have catalysed agitations and social disharmony.
• Electoral outcomes in favour of extreme positions in mature democracies such as the U.S., the U.K., France and Germany in the last decade may partly be a reflection of voters’ sense of deception over economic gains.

Way forward

• It is time for India’s political leaders to not be drawn into argument over GDP growth every quarter and instead clamour for an overhaul of India’s economic performance measurement framework to reflect what truly matters to the common person.

Conclusion

GDP growth has turned into a misleading and dangerous indicator that portrays false economic promises, betrays people’s aspirations and hides deeper social problems.

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Context

The Finance Minister, Nirmala Sitharaman, said recently that India’s long-term growth prospects are embedded in public capital expenditure programmes. She added that an increase in public investment would crowd in (or pull in) private investment, thus reviving the economy.

Significance of public investment-led economic growth

• Public investment-led economic growth forms a credible strand of explanation for India’s post-Independence economic growth. 
• Revival after Asian financial crisis: When it was faced with a slow-down after the Asian financial crisis of 1997, the  government initiated public road building projects.
• In the form of the Golden Quadrilateral and the Pradhan Mantri Gram Sadak Yojana, these initiatives sowed the seeds of economic revival, culminating in an investment and export-led boom in the 2000s; GDP grew at 8%-9% annually.
• In comparison, the investment record during the 2010s has been dismal.
• However, a recent uptick is evident in the real gross fixed capital formation (GFCF) rate — the fixed investment to GDP ratio (net of inflation).
• The ratio recovered to 32.5% in 2019-20 from a low of 30.7% in 2015-16.

Analysing the Investment distribution

• As in the June edition of the Ministry of Finance’s Monthly Economic Review, the fixed investment to GDP ratio was 32% in 2021-22.
• However, there is need for caution in reading the most recent data, as they are subject to revision.
• Moreover, the budgetary definition of investment refers to financial investments (which include purchase of existing financial assets, or loans offered to States) and not just capital formation representing an expansion of the productive potential.
• The National Accounts Statistics provides disaggregation of gross capital formation (GCF) by sectors, type of assets and modes of financing; over 90% of GCF consists of fixed investments.
• No change in investment distribution: The investment distribution has hardly changed over the last decade, with the public sector’s share remaining 20%.
• Fall in share of agriculture and industry: Between 2014-15 and 2019-20, the shares of agriculture and industry in fixed capital formation/GDP fell from 7.7% and 33.7% to 6.4% and 32.5%, respectively.
• Services’ share rose to 52.3% in 2019-20 compared to 49% in 2014-15.
• The rise in the services sector is almost entirely on transport and communications.
• The share of transport has doubled from 6.1% to 12.9% during the same period.
• Within transportation, it is mostly roads.
• Decline in the share of investment: Its share in the investment ratio (column 2.1) fell from 19.2% in 2011-12 to 16.5% in 2019-20.
• This indicates that ‘Make in India’ failed to take off, import dependence went up, and India became deindustrialised.
• Import dependence on China is alarming for critical materials such as fertilizers, bulk drugs (active pharmaceutical ingredients or APIs) and capital goods.
• Instead of boosting investment and domestic technological capabilities, the ‘Make in India’ campaign frittered away time and resources to raise India’s rank in the World Bank’s Ease of Doing Business Index.
• Decline in foreign capital in GFC: The contribution of foreign capital to financing GCF fell to 2.5% in 2019-20 from 3.8% in 2014-15 (or 11.1% in 2011-12).
• With declining investment share, industrial output growth rate fell from 13.1% in 2015-16 to a negative 2.4% in 2019-20, as per the National Accounts Statistics.

Way forward

• Need for balance: As roads and communications are classic public goods, investment in them is welcome.
• However, for healthy domestic output growth, there is a need for balance between “directly productive investments” (in farms and factories) and infrastructure investments.
• And this balance was missed.
• The recent upturn in the aggregate fixed capital formation to GDP ratio is positive, though the rate is still lower than its mark in the early 2010s.

Conclusion

The claim that the investment revival is public sector driven is not borne out by facts. The budgetary figures refer to financial investment, not estimates of capital formation, indicating expansion of the economy’s productive capacity.

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Back2Basics: Gross fixes capital formation

• Gross fixed capital formation (GFCF), also called “investment”, is defined as the acquisition of produced assets (including purchases of second-hand assets), including the production of such assets by producers for their own use, minus disposals.
• The relevant assets relate to assets that are intended for use in the production of other goods and services for a period of more than a year.
• The term “produced assets” means that only those assets that come into existence as a result of a production process are included.
• It therefore does not include, for example, the purchase of land and natural resources.
• This indicator is available in different measures: GFCF at current prices and current PPPs in US dollars, and annual growth rates of GFCF at constant prices, as well as quarterly data for percentage change over previous period and percentage change over same period last year.
• The indicator at current prices and current PPPs is less suited for comparisons over time, as developments are not only caused by real growth, but also by changes in prices and PPPs.

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