Union Budget 2024: Make domestic demand drivers the central theme on February 1

GDP growth is merely being driven by public capex and not household consumption.

“If it ain’t broke, don’t fix it” is an old adage that might perfectly gauge the thinking of Indian policymakers as they prepare the interim budget for FY25. Taking into perspective both Q2, as well as First Advanced Estimates, FY24 has been all about a public capex driven story.

The theme will, most likely, continue in the next financial year as well, given that consumption has taken a back seat and the private sector is still pondering the future. As things stand, the Indian economy is expected to grow by 7.3 percent in FY24, in real terms.

While the Government and experts are celebrating the feat, few are looking at the inherent weaknesses apparent in the estimated numbers.

What The GDP Data Says

A closer scrutiny reveals that in real terms, household consumption now contributes only 56.9 percent to the overall GDP – a full 150 bps lower than the previous year.

Moreover, the growth in final household expenditure, in per capita terms expanded by just 3.5 percent – half the growth witnessed the previous year. This is happening despite overall GDP per capita expansion of over 6.4 percent, which is a misnomer in itself.

Going by the way GDP per capita is calculated, what this means is that GDP growth is merely being driven by public capex and not household consumption.

This lower than usual household final expenditure growth (per capita) points towards inherent weaknesses in the economy, as wealth no longer percolates to the bottom of the pyramid.

At the same time public capex is expanding significantly and investment is now contributing 90 bps incrementally to the GDP, compared to the previous year. This mega expansion is buttressing metals, as well as core industries, but, at the same time, eroding fiscal capacity.

Moreover, Government expenditure is now lower from the perspective of real expenditure-based calculations and is barely pulling from the sectoral expansion vantage point.

Here the role of discrepancies becomes important, as the larger than usual figure is supplementing the lower expenditure/ aggregate demand led GDP.

GDP Vs GVA

Theoretically, the expenditure powered real GDP (minus consumer taxes), calculated via the aggregate demand methodology must be equivalent to the production powered real Gross Value Added (GVA) at basic prices, plus effective subsidies.

The residual here can be considered as tax leakages.

Positive discrepancies generally occur when this production powered GVA is larger than the former.

This happens because the production methodology records variables such as wages, corporate profits, and depreciation (measuring capital goods usage), that are not recorded by the expenditure method.

During an economic cycle where public capex outflanks household consumption, the production led real GDP records a higher number by the function of what is measured.

Consequently, the number derived from the expenditure methodology must then be compensated, through what we call the ‘discrepancies’ variable – just to balance the equation.

Fiscal Data 

This brings us to the Government’s fiscal space that might be running thin. As soon as fiscal constraints go beyond a limit, and the private sector (including households) fails to take over, the growth story falls on its back.

As a remedy, the only option for the Government is to keep pedal to the metal on capex without focusing too much on the fiscal responsibility and budget management (FRBM) mandates.

Assuming that the fiscal deficit is kept at 6 percent of nominal GDP by the budget setting committee, it is safe to believe that the nominal GDP growth for FY25 will be estimated somewhere near the 10 percent ballpark, considering a lower deflator.

This will allow the Government an incremental fiscal space of roughly Rs. 1.8 lakh crore for capital expenditure for FY25.

What this means is that capital expenditure allocation (excluding grants-in-aid) might grow by over 18 percent, as compared to the current financial year.

Despite the somewhat benign yields because of several factors including bond index inclusions, interest payment obligations will remain elevated for FY25 as well, thanks to unavoidable net debt increases.

Government’s interest obligations for FY25 will be therefore higher than that of FY24, which saw these costs eating away 3.6 percent of the nominal GDP.

Bolster Consumer Sentiment

Since the exchequer has limited capacity going forward, taking cognisance of the situation, the Government must allocate resources for consumer subsidies for the revival of the household consumption.

Read | Budget 2024: After rate hikes and status quo, time for cuts is coming

While this strategy may delay the FRBM alignment by a year, and stoke inflationary tendencies briefly, the dovetailing effect will be significant for the economy, improving sentiments.

By providing interest subvention schemes (to low- and middle-income households) for the consumption of consumer durables, real estate, and automobiles, the budget can potentially revive India’s consumption story, helping normalize consumption disparities.

Possibly, incremental tax accruals can potentially pare down some of the fiscal losses incurred, and help the virtuous cycle to churn.

At the same time, the budget must seriously look at the rising stress levels among households, given the unsustainable growth in non-collateralised personal loans.

Importantly, policymakers must ensure that the conspicuous consumption of the rich does not dilute the challenges faced by the most vulnerable groups of Indian households.

Indeed, the old formula of capex driven growth is a proven way to continue economic expansion, the model has its limitations.

Policymakers must therefore remain mindful of the real challenges faced by the households and their falling financial capacities. India is a domestic demand driven economy for a reason, and this must be the central theme on February 1.

Karan Mehrishi is an economist, specialising in monetary economics and fixed income. Views are personal and do not represent the stand of this publication.