GDP growth and inflation will trend downwards in FY25

The GDP fine print reveals three clear trends.

India’s weaker-than-expected economic growth in the September quarter has set the dovecotes aflutter, prompting many to review their forecasts for this fiscal. At 5.4 percent, the gross domestic product (GDP), a number that records the expenditure or demand-side of the economy and incorporates the impact of indirect taxes and subsidies, was lower than the preceding quarter’s 6.7 percent and well below 8.1 percent in the corresponding quarter a year ago.

The number that records the production or supply side of the economy, termed as gross value added (GVA) by sector, also indicated a slowdown in momentum at 5.6 percent.

The loss of pace for the second quarter in a row confirms a slowdown. Though largely anticipated, there are reasons why the slower growth needs closer attention.

The GDP fine print reveals three clear trends.

1. GVA-GDP gap’s normalising

First, for two consecutive quarters, the GVA and GDP growth rates have printed quite close to each other, indicating the gap between them has finally narrowed as per their historical relationship. This implies that the impact of tax collections and subsidy disbursal during and in the aftermath of the pandemic is finally normalising. Between the June 2023 and March 2024 quarters, the gap widened to as much as 1.8 percentage points.

Second, investment growth has slowed to 5.4 percent in the September quarter, from 7.5 percent in the preceding quarter and 11.6 percent in the September 2024 quarter.

This signals two things. One, the impact of a high base effect and, two, the impact of a weaker fiscal impulse due to lower government capital expenditure (capex). The latter, though, was anticipated as the Union Budget had announced a moderation in the Centre’s capex growth to about 18 percent this fiscal from over 25 percent in the last – a move that allows the government to maintain focus on fiscal consolidation and allocate higher government consumption spending on schemes that help in employment generation.

2. Consumption emerging as a growth driver

Third, so far this year, private consumption seems to be holding up better and possibly switching roles with investment to push growth. In the September quarter, private consumption grew faster than investments, at 6 percent.

Though urban demand is slowing, stronger rural demand appears to be fanning private consumption. The agriculture and allied sector logged the fastest growth in five quarters, at 3.5 percent, reflecting improvement in rural incomes.

A low base from last year is another factor aiding the lift.

3. Reprioritising of government spending boosts private consumption

We believe higher government consumption spending is lifting private consumption. While capex has a larger and longer-lasting positive impact in the long run, government consumption spending tends to have a reasonable short-term multiplier impact on private consumption.

In our note titled, ‘Rekindling Private Consumption’, we looked at 13 years of national accounts data to ascertain this. In most years that government consumption spending slowed, private consumption dipped in tandem.
Last fiscal, government consumption spending slowed to 2.5 percent from 9 percent in fiscal 2023 and is suspected to be a factor (in addition to weaker rural incomes and high food inflation) in causing the slowdown in private consumption. Behind weaker government consumption spending was the normalisation of spending on key schemes as the economy gained strength.

In rural areas, in addition to agriculture, the bulk of households are also employed in non-agriculture and allied activities, including construction resulting from schemes focused on the construction of rural roads, housing, and the Mahatma Gandhi National Rural Employment Guarantee Act works.
With rural incomes and demand facing challenges, some support was restored in this year’s budget – budgeted outlay on the schemes in the above-mentioned areas is up nearly 21 percent this fiscal compared with a 14 percent cut last fiscal. A pick-up in government consumption spending is expected to support private consumption growth, too.

In the September quarter, government consumption spending recovered to 4.4 percent after a 0.2 percent fall in the June quarter. Meanwhile, construction sector GVA, where a reasonable push from spending on the schemes is expected, expanded a strong 7.7 percent.

Two of the three consumption growth drivers are visible

Our earlier-quoted study indicates that a consumption revival hinges on three key factors – higher government spending, better agriculture performance-led improvement in incomes, and lower food inflation. Of these, the first two have gained momentum, while the third has worsened. But the income effect appears to be dominating, for now.
For the rest of this fiscal, we expect private consumption to play a larger role in driving growth. For the third quarter, festive demand and the wedding season are expected to support the growth momentum.

Weak urban demand needs attention

But the weakness in urban demand warrants a closer look. The Reserve Bank of India’s (RBI) Consumer Confidence Index continues to report sluggishness in urban demand. Headline inflation staying above the RBI’s comfort zone is keeping rate cuts at bay and the cost of credit high.
High interest rates and cautious lending by banks are also playing a role in slowing bank credit growth, including retail loans. The RBI’s November bulletin reports, “Several private banks are reported to be experiencing stress in small-ticket advances, credit cards and personal loans, with a rise in over-leveraged clients as well as in provisioning. More generally, banks have circumspectly reined in lending to retail and services.” Slower retail credit off-take could be driving weaker urban consumption demand.

GDP and inflation will trend downwards in FY25

We expect GDP growth to slow to 6.8 percent this fiscal after a high 8.2 percent last year, weighed down by high interest rates and low fiscal impulse. Risks are tilted towards the downside given the lacklustre second-quarter growth number.
Coming quarters are expected to see food inflation soften as kharif supplies enter the market and cool prices. But the rigidity in vegetable prices and firming global edible oil prices pose risks.
We expect consumer price inflation to print at 4.6 percent this fiscal, down from 5.4 percent in the last, and the Monetary Policy Committee to maintain status quo in December and cut rates towards the end of this fiscal.