In early November, I wrote a piece suggesting that the Indian economy is functioning as expected: muddling along. It rarely falls into a full-blown recession, but it also struggles to achieve sustained acceleration. This observation was immediately illustrated when India’s gross domestic product (GDP) growth, after reaching 8.2% in FY23-24, fell to 6.6% in the Q1FY24-25 and then further to 5.4% in Q2FY24-25. Growth is unlikely to return to 8% any time soon, but it also seems unlikely to dip below 5%.
If the original 'Hindu rate of growth' was 3.5% (the average annual GDP growth between 1950 and 1980), the new Hindu rate of growth is 5.5%. The official reasons for the economic slowdown in the last quarter are varied: one, the Reserve Bank of India's (RBI's) restrictive monetary policy; two, lower government capital expenditure (capex) due to the ongoing general and state elections; and three, a slowdown in private sector capex due to domestic political factors, global uncertainties, excess capacity and fears of dumping in India.
While these explanations are accurate, they are merely proximate causes at the moment. The underlying reasons can shift. Next time the GDP numbers are announced, the slowdown could be attributed to global economic weakness, rising oil prices, or another drop in domestic capex. The essential fact remains that the Indian economy is weak—hampered by poor policies, poor governance (including high levels of corruption) and a high-cost, low-output structure.
The government's monthly economic review for November 2024 points out that “private capex levels are affected by global uncertainties, excess capacity, and fears of dumping.”
These are structural issues that cannot be solved quickly. How, then, will private capex suddenly rebound in the coming quarters?
The Indian economy has largely been on auto-pilot, delivering only modest growth. While our growth may be higher than many other countries, it is not sufficient to propel India rapidly into middle-income status. The prospect of India entering the 'rich country' club remains a distant dream.
The critical question is whether the stock market reflects this reality. A 6% growth rate is good but not a sufficient reason for a runaway bull market, especially when Indian stocks, particularly in the small-cap sector, have had an extraordinary run in the past two years.
The S&P BSE Small-cap Index rose 47.52% in 2023 and 29% in 2024. The Nifty MicroCap 250 Index did even better, jumping 66.44% in 2023 and 34.35% in 2024. Meanwhile, the Nifty50, weighed down by the slow growth of giant stocks, rose by only 20% in 2023 and 9.58% in 2024; yet for the ninth consecutive calendar year, the index is poised to close in the green. And yet, it would be naive to assume that these exceptional returns will continue indefinitely.
The question that investors should ask is: If economic growth remains modest (at around 6%), can the small- and micro-cap sectors continue to deliver extraordinary revenue and profit growth?
There is a case to be made for smaller Indian companies continuing to record strong growth. Since the last quarter of FY22-23, they have benefited immensely from massive government spending. After years of slow economic growth, the Modi government tried to boost it by spending around Rs11 lakh crore annually on infrastructure projects such as railways, roads, urban transport, waterworks, energy transformation and defence production.
Government capex as a percentage of total expenditure reached 28% in FY23-24, up from just 14% in FY13-14. However, while government capex increased by 33.7% last year, it contracted by 6.6% in April-October of FY24-25. As the main engine of India’s economy has slowed, GDP growth has also weakened.
There are expectations that government capex will rebound sharply in the last quarter of this year which is, typically, stronger than other quarters. However, the challenge with relying on government capex is that it is heavily dependent on government revenues and those are weakening.
With the economy now settling into the 'new Hindu rate of growth,' the growth in Central government gross tax revenues has fallen to 10.8% in April-October FY24-25, compared to 18% in FY22-23 and 14% in FY23-24. Similarly, goods and services tax (GST) collections have slowed significantly. After a 26.2% growth in FY22-23, as the economy rebounded from COVID-19, GST collections grew by just 11.9% in FY23-24 and 9.3% in April-November FY24-25.
Other worrying signs are emerging as well. In April-November FY24-25, growth in power consumption slowed to 3.9%, down from 9.7% in FY23-24. Cement production increased by only 1.8% during the same period, while fuel consumption grew by just 3.3%.
While it is too early to draw definitive conclusions, if these weak indicators persist, there is a risk that India could slip into a prolonged slowdown similar to the one experienced between 2014 and 2019. The best-case scenario is that these markers improve only slightly; after all, there is no reason for them to improve sharply.
Where are the engines of growth?
Regardless of whether we face the worst-case or best-case scenario, what happens to the high growth expectations already priced into the stock market, especially in smaller companies, after two consecutive years of exceptional returns? That is the key question for investors.
(This article first appeared in Business Standard newspaper)
Comments
Kamal Garg
2 weeks ago
It is indignant upon such a highly respected and caliber journalist to coin a new term "new Hindu rate of growth". India is growing and advancing - it is slower than its potential because of two critical main factors - a very large and poor population, and running and vibrant democracy which compels many things like going to the electorates for votes every now and then, and of course an upright and beholder of justice , i.e. SC. You show me any other country in the world with these two/three characteristics and delivering a better rate of growth, sustainably for decades.
Since you bring up the Nehruvian/Leftist slur of "new Hindu rate of growth" , May I ask you what is the Muslim rate of growth or Christian rate of growth?
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