Like the U.S., is India headed towards recession?

Two bad news hit this month. First, the World Bank projected a sharp decline in global output growth in the current fiscal – from 5.7% in 2021 to 2.9% in 2022. In January, before the Russia-Ukraine war broke out, it had projected a 4.1% growth. The impact is very sharp and given that there is no sign of an early end to the Russia-Ukraine war, there could be a further dip.

For India, it brought down the growth projection for FY23 (April 2022-March 2023) to 7.5% – from 8.7% projected in January 2022. The RBI too has lowered India’s growth projection from 7.5% in April to 7.2% in May and June. The further dip is likely for both internal and external factors.

The war’s adverse effects on global commodity markets, supply chains, inflation and financial conditions are now very clear. But the bank report says, there are other risks. It warns of 1970s-type stagflation, which could eventually lead to a sharp tightening of monetary policy (higher interest rates) in advanced economies and possibly culminate in financial stress in some emerging and developing economies.

For India, it marks several distressing signs: Omicron and war slowing down growth in the first half of 2022, headwinds from rising inflation, labour force participation rate (LFPR) below the pre-pandemic levels and shifting of workers to lower-paying and precarious jobs.

The second bad news is the fear that the U.S. economy might go into a recession – adversely impacting other economies.

This fear emerges after it was noticed that the U.S. treasury “yield curve” inverted on March 29, for the first time since 2019. In simpler terms, the yields on two-year treasury notes were found to be higher than the 10-year treasury notes – which should be the other way round as longer duration treasury notes yield more. Such inversion in the yield curve is considered a sure sign of impending recession. This had happened in the US each time since 1955, with the recession following in the next 6 to 24 months.

Raghuram Rajan, now back to academia in the U.S., says the U.S. “can still come out of this with no recession but the base case has to be a mild recession sometime next year”. Europe too is going through economic turmoil because of the war and the post-pandemic pangs. Fortunately, there is no sign of inversion in the treasury yield curve in India.

The RBI’s last two statements show the yields from various treasury bills – 91-day, 182-day, 364-day and 10-year – are all in the right order. That is, treasury bills of higher durations are fetching higher yields in each case in May and June (up to June 10).

Nevertheless, there are many distressing signs that India’s growth may be far worse than the projected 7.2%.

Multiple distressing signals

Now that the four quarters of data for FY22 are available, it shows the GDP and PFCE (private consumption) are 1.5% and 1.4% higher than the respective levels of FY20 but the per capita GDP and per capita PFCE are below the FY20 level – by -0.5% and -0.6%, respectively. This means while the national income and private consumption have crossed the pre-pandemic level when adjusted against the population, they have not. Further, since GDP and PFCE include non-households, the households’ financial health would be much worse.

The long-term trends confirm this.

The growth in per capita GDP and PFCE has been falling sharply since FY17. In the case of the first, growth fell from 6.9% in FY17 to 2.7% in FY20 (pre-pandemic) and for the second, growth fell from 6.8% to 4.1% during the same period. The growth rates in FY21 and FY22 are identical but inverse – that is, the rise in FY22 matches the fall in FY21 (per capita GDP at -7.6% in FY21 and 7.6% in FY22; per capita PFCE at -7% in FY21 and 6.9% in FY22). The prospects for FY23 are turning bleak due to high inflation and worsening other internal and external conditions.

The headline CPI inflation has crossed 6% consistently from January 2022 onwards, breaching 7% in April 2022 – which is higher than the RBI’s upper tolerance band. The RBI woke up to the inflation threat in May to make off-cycle revisions in key policy rates (CRR by 50 points and repo by 40 points). In June, it raised the repo rate by another 50 points and indicated a further rise in policy rate/rates in the latter part of the year as it expects the headline inflation to remain above the upper tolerance limit of 6% for the entire FY23 – at 6.7%. WPI inflation has remained elevated, at 12.9% in FY22, touching 14.6% in March and is unlikely to change given the rising commodity prices.

Then there is a chronic job crisis with little sign of improvement. The open unemployment rate, which touched a four-decade high of 6.1% in 2017-18, as per the PLFS report, remains elevated. The CMIE data shows the rate ranges from 6.6% to 9.2% every month from June 2021 to May 2022. Poverty, hunger and income inequality were going up even before the pandemic hit. The prolonged pandemic has worsened these conditions – which will only be known accurately when household consumption expenditure and loss of jobs and businesses are known.

When all these indicators are taken together, the financial health of households has deteriorated considerably. In such a situation, it would be naïve to think the economic fundamentals are still strong and poised for rapid growth.

A business daily’s estimate says India falls in the bottom half of 20 major economies (12th position) in the measurement of the “misery index” – which takes into account inflation, unemployment, interest rate and growth in per capita income – even as at 8.7% growth in FY22 India is the fastest-growing major economy.

Declining savings and investments

India’s future growth prospects are dim, too, because of declining trends in other economic indicators.

For example, gross domestic savings and household savings have been steadily declining and so is capital formation (GCF) or investment in the economy. In the past 15 years, the National Accounts Statistics show gross domestic savings have fallen from a high of 37.8% of the GDP in FY08 to 31.4% in FY20 and household savings have fallen from a high of 25.2% of the GDP in FY09 to 19.6 in FY20.

This indicates falling income (less saving) and impoverishment of households – a clear indication of progressively slowing down of the economy that began in the UPA-II. Capital formation (GCF), too, has fallen from a high 42% in FY08 to 27.3% in FY21 – another indicator of a slowing economy as an investment provides growth impetus.

Further, the FIIs have pulled out $21.3 billion in the first five months of 2022 (January to May), the highest ever. The only positive sign is FDI inflows, which have increased by a mere 2% in FY22 over FY21 – from $81.8 billion to $83.6 billion – as per the Department for Promotion of Industry and Internal Trade (DPIIT).

These are bad signs for good growth.

GDP growth to slip much below 7.2%

7.2% GDP growth for FY23 is more likely an overestimation. Here is why.

The RBI’s FY23 growth projection is based on quarterly GDP numbers of FY22 and several assumptions. The quarterly GDP numbers (the fourth quarter’s numbers were released on May 31) are based on formal sector indicators and a small part of the informal sector (like, crop production). The actual GDP size for FY22 (8.7%) is likely much less as the informal sector (nearly half the GDP) has been hit harder by the pandemic than the formal sector. Using formal sector data for the informal sector is surely an exaggeration in GDP estimation for FY22.

As for the RBI’s assumptions in GDP projections, one has already gone wrong by miles. It projected CPI inflation of 5.7% for FY23 in its April monetary policy statement (which had taken into account the war fallout and rising crude prices for months by then). Now it has revised inflation to 6.7% – one percentage point higher. At the same time, its GDP growth projection has fallen by just 0.3 percentage points – from 7.5% in April to 7.2% in June. It should have fallen far more.

Why the RBI should have reduced FY23 growth will be clear from the National Accounts Statistics for FY22. While the CPI inflation for FY22 was 5.5%, the GDP deflator (adjustment for inflation) was much higher at 10.8% – “nominal” GDP growth was 19.5% against “real” GDP growth of 8.7%, the difference accounting for inflation. This shows, that the GDP inflation (deflator) is much higher than the CPI inflation and so the change in the CPI would hit the GDP harder.

Then, the RBI is tightening the money supply, which will slow down growth. The repo rate has already been raised by 90 points and CRR by 50 points in May and June. The repo is expected to go further up later in the year, if not CRR. A higher interest rate slows down growth by directly choking credit-driven economic activities, which is aimed at cutting down demand. This is a global phenomenon.

With global growth projected to go down drastically – from 5.7% to 2.9% – India’s imports and exports would also be adversely impacted. How long the war would continue is not known but many expect it to linger on to 2023. A prolonged war would progressively damage global and India’s growth prospects.

A fall in GDP growth will adversely impact revenue resources.

The revenue receipt of ₹22 lakh crore budgeted for FY23 is 6% more than that of the revised estimates for FY22, while GDP growth for FY23 is 11.1% (nominal) in the 2022 budget. This is unusual (inversion) as revenue collections tend to grow at a faster rate than GDP. A lower revenue collection would then choke government expenditure by that extent.

Further, states’ finances would be under severe stress with the discontinuation of GST Compensation.

The 15th Finance Commission estimated a shortfall in state GST (SGST) at “about ₹7.1 lakh crore” between July 2017 and June 2022. It was this shortfall that was bridged through the GST Compensation. There is no reason to assume that the shortfall will stop from FY23, but there would be no compensation. How will states meet the shortfall? With both central and state short of revenues, fiscal expenditures would come down, and so would the growth.

All these factors would then combine to make a deadly cocktail to hurt growth in FY23.

India may not end up in a recession, as many fear for the U.S. now, but the slowdown of the economy is evident. If at all, it will be a ‘technical recession’ involving two-quarters of a shrinking economy (the global definition of recession). Yet, India’s GDP growth would still be among the highest in the world. The GDP growth is falling from 8.7% in FY22 to a projected 7.2% in FY23. All indicators, presented earlier, point to a sharper fall than a 7.2% growth. The only engine to put a break is government spending (GFCE) but it is too small for that, at 10.7% of the GDP in FY22 – down from 11.3% in FY21. Remember, the economy was on a prolonged slowdown. The GDP growth in the pre-pandemic FY20 was just 3.7% – rapidly sliding from 8.3% in FY17.

Even by assuming that India has fully recovered from the pandemic hit, the growth would still be somewhere closer to the 4% mark rather than to the 7-8% mark. That is because for the past two years, India, like any other country, is fighting to recover from the pandemic setback. The RBI’s assessment says, it would take India 13 years (up to FY35) to recover the pandemic loss, if the ‘real’ GDP grows at 7.5% annually, beginning with FY23.[x] India is already missing that target in FY23 by miles.

In the meanwhile, nothing dramatic has happened during the pandemic to assume that the GDP growth would jump to 6-8% witnessed during FY15-FY19. Hoping for that in FY23 and further would be a shot into the dark.