On 6th June, the Reserve Bank of India (RBI) surprised the markets, slicing the repo rate by 50bps (basis points) to 5.5% and cutting the cash reserve ratio by 100bps, phased over four 25-point tranches from September to November. The move, expected to inject Rs2.5 lakh crore into the system, briefly lifted spirits: the NIFTY index climbed 1% that day, with a modest gain the day after. But the index has not advanced much since then. The rate cut is a sideshow.
With the RBI shifting its stance to 'neutral' from 'accommodative,' there will be no 'easing cycle'. A 100bps cut will do little to spur demand. The immediate reason: overall growth expectations are modest.
RBI’s expected growth in gross domestic product (GDP) is projected to be the same 6.5% as last year and consumer price inflation slightly lower. The real reason: the four main economic drivers of the economy are stuck in a low gear.
Consider consumption first. Private final consumption expenditure (PFCE), which makes up nearly 60% of India's GDP, fell from a growth rate of 6.8% in the years before COVID to 4.1% in FY19-20. After a brief post-pandemic recovery, it fell back again, to 5.6% in FY23-24 according to RBI and an even weaker 4.4% according to the National Statistics Office (NSO).
The consumption rebound was short-lived because it was led by debt and higher welfare spending by the government. After all, average income growth in most sectors (engineering, financial services, retail, information technology, logistics and consumer goods) was outpaced by inflation. But debt-funded consumption has its limits. Since mid-2023, the credit growth of personal loans has fallen off the cliff (from 22% down to 10% or so now), reducing consumption.
The second element in GDP growth is net exports. Indian exports are a disaster. Large headline stories—like growing cell phone exports—mask a poor overall performance in merchandise exports which fell 12.8% in 2023-24 and grew by only 2% in 2024-25. Net exports (exports minus imports) are a component of GDP growth. Year after year, India’s net exports are negative.
India has no control over imports (fossil fuel and gold imports are inelastic) and benefits only when prices of these commodities are down. It cannot boost exports either because the enormous cost of doing business saps the productivity and competitiveness of Indian exporters. India’s services exports and enormous remittances partly reduce the impact of poor net exports.
The third driver of GDP growth is private capital expenditure (capex). There is a lot of bullish anecdotal evidence about shining new factories coming up but the most comprehensive and authentic set of data is not rosy. According to the Forward-Looking Survey of the ministry of statistics and programme implementation, actual intended private sector capex will fall from Rs6.6 lakh crore in FY24-25 to Rs4.9 lakh crore in FY25-26, down 26%. The survey was confined to large enterprises.
Among the small and medium enterprises, the mood is worse. The reason for sluggish spending is sluggish demand, which can be traced back to the Indian State, that comes in the way of creating a thriving, competitive and innovative business climate. This leads us to the fourth engine of growth—government capex, probably the most important one currently.
India is continuing with the old model of dominant state, extorting a lot of money from businesses and citizens in ever-increasing variants, even in a period of sluggish growth. Notice that manufacturing and export growth are miserably low and even large companies are struggling to increase their revenues beyond single digits. But the government’s take from goods and services tax (GST) between FY19-20 and FY24-25 expanded by an astonishing 19.46% compounded annual rate. In FY22-23 and FY23-24, capitalising on GST collections and adding huge borrowings to the pot, the government massively increased its spending.
The Budget 2023-24 announced a capital outlay of Rs10 lakh crore, which was increased to Rs11 lakh crore in 2024-25, to be spent on railways, roads, urban transport, waterworks, energy transformation and defence production. This boosted growth for two years. But despite large allocations, actual government capex was surprisingly sluggish in FY24-25.
There was no growth in FY24-25, while revenue expenditure went up, leading to a 22% revenue deficit. In a society where the rule of law is weak, corruption is rampant and red tape is entrenched, limitations to government capex as a driver of growth are obvious. Also, if tax-and-spend was expected to trickle down, it has failed; India’s rural wages and job growth are stagnant which has wrecked consumption growth.
Clearly, it is not for RBI and its monetary policy committee (MPC) to fix any of these deep structural issues and magically create growth. If any evidence were needed that the current economic strategy is not working, payroll growth is a definitive one.
According to government data, net payroll additions under the employee provident fund were -5.1% in FY23-24 and -1.3% under FY24-25. Naukri Jobseek Index of white-collar jobs has flattened since FY22-23. Weak job creation reflects how ineffective the headline 6.5% GDP growth really is; it also hobbles consumption, the economy’s lifeblood. We need to face facts: what we have is a structural, not a cyclical issue.
If the economy is seen to be doing ‘well’, it is mainly for the well-off. We are running far below our true potential and what is needed to lift millions of people rapidly from poverty.
(This article first appeared in Business Standard newspaper)
Comments
adityag
4 weeks ago
Central banks are slowly becoming irrelevant. Their actions do not move the markets like it once did.
Also, it is time to replace Fiat system with something more robust. Revert back to gold standard. Or move to blockchains and remove governmental interference. Let markets decide interest rates. This will reflect structural economy more accurately. The days of playing cat and mouse with central banks are over.
The conclusion of the article that the economy is doing well, it is for the well off , reflects and captures well of the present state of affairs of the people less well off in the society . The monetary policy no doubt has changed it’s stance from accommodative to neutral but it really accommodates the borrowers particularly in the manufacturing segment and industrialists to think of expanding their investments and go on for enhanced production and employment through cheap credit though the overall cost of production remains unattractive thanks to irrational gst , uncertainties in the geo political conditions , and not so favourable international economic scenario . The fiscal policy needs to be tuned a lot more in tune with monetary policy to strengthen the structural weaknesses in the economy to improve employment , lessen inequality , remove corruption , black money and malpractices seen in governance everywhere . All said RBI has been found to be very understanding and accommodative but a lot remains to be done to fully exploit the talents , potential resources and achieve the dream of becoming the most advanced economy by 2047 . The vision is encouraging and clear but the path has hurdles but manageable .
Reactions of equity markets to RBI policy are at best secondary and meaningless to the least. Long duration bond markets yields spiked up disproportionately as compared to short duration yields, resulting in serious erosion of LT bond prices on each and every day from policy day till last friday as investors are simply dumping long term bonds due to outlandish policy built in with too many weapons , an upfronted rate cuts, massive liquidity flush, change of stance to neutral and to top it explicit announcements by the governor that nothing is gonna come in the next few policies...this is killing longterm bond prices pulling down NAVs of LT debt funds inspite of deep rate cuts. A serious readjustment of sorts. Certainly this carries a cost to the govt. in terms of stiffened yields on the long duration end raising cost of long term money to the govt. as well. No wonder today RBI governor is sounding sheepish that scope for cuts do exist if inflation is below expectation...though it is needless to tell bond markets
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Also, it is time to replace Fiat system with something more robust. Revert back to gold standard. Or move to blockchains and remove governmental interference. Let markets decide interest rates. This will reflect structural economy more accurately. The days of playing cat and mouse with central banks are over.