Our broken growth model is in acute need of some repair work

India was expected to grow in double digits in 2021-22. This was primarily because of the contraction of our economy in 2020-21. The low base of the last financial year would have made economic growth this year look good.

However, most double-digit economic growth forecasts for the current financial year have been cut to single digits. The International Monetary Fund recently cut its growth forecast for India from 12.5% to 9.5%.

Of course, the two covid waves have had a huge role to play in this. Nevertheless, even pre-pandemic, India’s economic growth model of recent years was in the process of breaking down. But before we get to that, it’s important to look at what drove economic growth during the first decade of the new millennium and a few years after.

The two things that drove economic growth were investments and exports. Our investment to gross domestic product (GDP) ratio was at 26% in 2000-01. By 2011-12, it had jumped to 34.3%. Exports jumped from 13% to 24.5% of GDP during the period. They rose further to 25.4% in 2013-14. This drove growth like never before.

The story started to unravel thereafter. Inflation hit double digits. Corporates found that they had been a little too optimistic in their assumption that India would be the next China. Projects did not take off on time, leading to huge bank loan defaults. Also, some business promoters simply siphoned off money borrowed from banks.

This led to huge bad loans for banks that peaked at ₹10.36 trillion, as of 31 March 2018. More importantly, this pushed banks away from funding industrial projects. Also, many corporates were not in a position to borrow, having already gone on a borrowing binge. In the process, India’s investment to GDP ratio fell. In 2020-21, it was at an almost two-decade low of 27.1%. Even before 2020-21, between 2015-16 and 2019-20, it had been in the 28-29% range.

Meanwhile, Indian exports fell to 18.7% of GDP in 2020-21. Even between 2015-16 and 2019-20, these were in the 18-20% range. This fall has primarily been driven by a massive fall in outward shipments of goods.

Nevertheless, private consumption, or the money you and I spend on buying things, came to the rescue. It continued to grow in double digits post 2011-12 and up until 2016-17. After that, consumption growth declined, but up to 2019-20, it was still very close to 10% per year. The trend led to consumption’s share in our economy increasing from 56.2% in 2011-12 to 60.5% in 2019-20. In 2020-21, consumption contracted by 6%, leaving it at 58.6% of GDP.

Private consumption was funded through savings as well as increased borrowings. Bank lending to the retail sector increased from 9% of GDP in 2011-12 to 14.3% in 2020-21. There has also been an explosion in retail lending by non-banking finance companies.

This is something that cannot continue indefinitely, given that the ability of people to repay loans and of banks to give out fresh retail loans depends on income growth. Per capita gross national disposable income grew in single digits between 2014-15 and 2019-20. Growth in 2019-20 was just 6.8%. In comparison, this growth had stood at 16.9% in 2010-11.

Also, it is worth remembering that this is the average income growth of Indians and not the income growth of an average Indian. These are two very different things. It is safe to say that the income growth of an average Indian must have been even slower.

In this scenario, if income growth has to pick up, investment needs to go up in order to create jobs and spur economic activity. The trouble is that many businesses are not in a position to borrow. Even if they are, the capacity utilization in many sectors continues to be low, which means that producers have no need to expand unless consumer demand rises to justify it.

Consumer demand is a function of income growth. Income growth, in turn, depends on investment. This has become like a chicken-and-egg story, which has proven difficult to break.

On exports, there has been some good news this year. India’s goods exports between April and July stood at $130.5 billion, almost 22% higher than between April and July 2019.

If India must extricate itself from this situation, both central and state governments need to spend more. This could involve everything from putting more money directly in the hands of citizens in the form of tax cuts to spending more money on capital-intensive infrastructure projects. Cutting excise duty on petrol and diesel could be a small start.

The worry here is that this will involve governments having to borrow more in a situation where the liabilities of the central and state governments have already touched around 91.7% of GDP, as of March 2021, which is a very high figure for an emerging economy.

While economists, politicians and analysts like to talk of clear-cut solutions for every situation, the one we are currently in doesn’t have an easy way out. Our two waves of covid, along with the breakdown of India’s growth model prior to that, have left the Indian economy on a wing and a prayer.

Time, it is often said, is the greatest healer. The Indian economy needs time to heal, and quite a bit of it.

Vivek Kaul is the author of ‘Bad Money’.