How to give a demand boost to the Indian economy that it so badly needs

Creating jobs is the most effective way to give a demand boost to the economy.

The Indian economy expanded 8.4 percent in the third quarter of the current fiscal that pushes up the growth for the full fiscal year to 7.6 percent. That is an impressive GDP growth rate by any standard. However, the biggest disappointment remains the private consumption which is now expected to grow by 3.01 percent in FY 2023-24 instead of 4.4 percent as given in the first advance estimate.

This is the slowest growth in private consumption since 2002-03 when it moderated to 2.9 percent, except during Covid pandemic (2020-21) which saw it contracting 5.3 percent.

To sustain 7-8 percent GDP growth, consumption must grow as it accounts for as much as 55 percent of the Indian economy.

The Struggling Middle

Unfortunately that's not happening. This signals severe financial stress among Indian households. To be more specific, the rich and affluent households don’t need any support and the poorer ones are being taken care of through a series of social welfare schemes starting with free ration to free housing and direct cash transfers. It’s the middle income households which are left to fend for themselves from a compounding effect of sticky inflation, sluggish jobs market and slower growth in disposable incomes. That is adversely affecting their demand for goods and services, and in turn the  growth of private consumption.

An improvement in the purchasing power of the poor will support the demand for essentials such as food and clothing. But that won’t be enough. It’s the relatively affluent middle-income households that drive the demand for high-value discretionary items such as consumer durables, education, health and recreation services, and homes. Unless they get some relief in the form of lower taxes on their incomes and/or consumption, households’ demand, and in turn, investment from India's private sector will stay muted.

In the absence of sufficient demand, supply side measures such as slashed corporate taxes, increased import barriers and PLI subsidies are turning out to be largely ineffective when it comes to achieving a broad-based revival in the private capex. Unless addressed, this demand gap problem will eventually cap India’s GDP growth rate.

Reduce Taxes

Over 32 percent jump in net indirect direct tax in Q3 of the current financial year which largely explains the wide gap between GDP and gross value added (GVA), shows that the government is successful in pruning down wasteful subsidies. That should enable it to prune down taxes on consumption in order to give a demand boost to the lndian economy that it so badly needs, at present.

Thus, it’s time to cut the GST to make goods and services cheaper and lift up consumption. Since GST rates are already low for essentials, that would mean the government needs to reduce them on discretionary goods and services, especially those which have strong backward and forward linkages with multiple industries, for instance, automobile and real estate industries.

India's automobile industry is hampered because of excessive regulatory rent-seeking and a rush to adopt tighter emission control. Creating jobs is as important as curbing air pollution. We are not closing all coal-fired power plants to push clean energy. Similarly, we should not penalise conventional internal combustion engine  (ICE) vehicle sales (vis-a-vis EVs) by imposing exorbitantly high taxes on vehicles and fossil fuels. It’s worth mentioning that EVs are not as green as we tend to believe and they are increasing India’s dependency on Chinese imports.

Similarly a combination of high GST, stamp duties and registration charges are keeping home prices high and making them unaffordable. Reducing GST will support these two crucial industries and also give a demand boost to dozens of dependent industries, starting from steel, cement, electrical equipment and sanitary fittings to home furnishings and interior decoration.

As of now, the slashed tax rate on profits applies only to private and public limited companies. It's time to extend the benefit to LLPs. That will help small business entities and first time entrepreneurs in the formal sector. That in turn will create additional jobs and further promote self-employment at a time the supply of jobs substantially lag behind their demand.

Creating jobs is the most effective way to give a demand boost to the economy and that will not be possible without helping SMEs which tend to be more labour intensive than larger corporations. However, they suffer from increasing cost of compliance due to ever-increasing filings and reporting requirements. Addressing these issues does not cost anything but political will.

Focus On Exports

Export could be another major source of demand for Indian businesses when domestic demand is sluggish. There are many ways in which the government can help. It needs to be recognised that excessive import protectionism increases the relative attraction of domestic markets leading to neglect of export markets which tend to be tougher to crack and bring in lower profit margins, especially when India’s export basket is dominated by largely undifferentiated commodities, be it agricultural goods or apparels.

We should not stop supporting indigenous manufacturers by checking unessential imports. However, a weaker exchange rate is a far more effective way to check  imports (than opaque import duties and non-tariff barriers) as it also makes it cheaper for foreign buyers to buy made-in-India merchandise. Therefore, instead of using import barriers to check imports and support domestic manufacturers, India should opt for a weaker rupee. That will discourage non-essential imports, and yet at the same time, incentivise exports which is a much bigger opportunity. Tapping that is better than solely relying on domestic demand to support growth.

Unfortunately, the Indian government has been raising import barriers, while the RBI has been too defensive about rupee’s exchange rate. It’s time to reverse this approach, more so when changing geopolitical dynamics provide an apt opportunity for India to push its exports as countries and corporations want to buy less from China.

To conclude, the 8.4 percent GDP growth in the Indian economy reveals a stark contrast when dissecting the components. While the overall economic expansion is commendable, the slump in private consumption is a matter of serious concern, but that can’t be tackled by supply side measures such as tax cuts and PLI subsidies alone. Lowering GST on discretionary items and allowing gradual weakening of rupee (instead of increase in import barriers) will provide the much needed demand side support to the Indian economy that it so badly needs.

Ritesh Kumar Singh is a business economist and CEO, Indonomics Consulting Private Limited, a policy research and advisory startup. He tweets @RiteshEconomist. Steven Raj Padakandla (@pstevenraj1) is a faculty at IMT, Hyderabad. Views are personal, and do not represent the stand of this publication.